macro econ theory
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slides-03.pdf
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MACROECONOMIC DATA (Ch 2)
• The role of observation in economics
• How to combine and systemize casual observations?
• Systematic and objective approach to gathering economic data
o Economic surveys
• Building macroeconomic statistics and indicators
o Gross domestic product
o Consumer price index
o Unemployment rate
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1. GROSS DOMESTIC PRODUCT (GDP)
• What does it measure? The market value of all final goods and services produced within a country in a given period of time
o GDP measures the total income earned by domestically located factors of production
o GDP measures the total expenditure on domestically produced final goods and services.
• Who estimates it? The Bureau of Economic Analysis (BEA) at the U.S. Department of Commerce
• How often? Quarterly and annually
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• How can GDP measure both income and expenditure? Because each dollar a buyer spends becomes income to the seller.
• Illustration: an economy with one good (bread) and one factor of production (labor)
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Stock vs. Flow Variables
• A stock is measured at a given point in time (e.g., wealth, capital, government debt)
• A flow is measured per unit of time (e.g., income, investment, budget deficit)
A flow or a stock?
• GDP
• Inflation rate
• Unemployment rate
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National Income Accounting • Adding "apples" and "oranges"
Consider an economy that produces only two goods: luxury cars and oranges. Say, 2,000 cars and 10,000,000 oranges per year. How much is the GDP?
The economy produces 10,002,000 goods, but cars are quite different from oranges, so just adding them does not make any sense.
Use market prices! Say, the price of a car is $500,000 and the price of an orange is $1. GDP = (price of cars × quantity of cars) + (price of oranges × quantity of oranges)
= ($500,000 × 2,000) + ($1× 10,000,000) = $1,000,000,000 +$10,000,000
= $ 1.01 billion
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• GDP includes currently produced goods and services, so used goods are NOT considered.
• Change in firms' inventories
Consider our car-orange economy and assume only one factor of production: labor. o If a firm decides to produce an additional orange, but does not manage to sell it
and it spoils, then the firm has spent more in wages, but has not increased revenues, so its profit would decrease with the cost of producing the orange. So, GDP would not change: higher wage is compensated by lower profit
o If a firm decides to produce an additional car, but does not manage to sell it this period, it can simply increase its inventory of cars. It is as if the firm has bought the car itself. GDP would increase. If the car is sold next year, then firm's inventory will decrease and consumer expenditures on cars will increase. These two effects would balance each other and GDP next year will not change.
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• Intermediate Goods and Value Added
Example: a farmer sells five oranges to a juice producer for $5 who uses them to produce a fresh orange juice and sells it for $7.
o Should GDP increase by $5, $7, or $12?
o The value added of a firm is the value of the firm's output less the value of all intermediary goods that the firm purchases. What is the value added of the juice producer?
Note: GDP is the value added by all firms in the economy
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• Housing Services and Other Imputations
o An imputed value is an estimate of the value of a good or service that is not sold on the market
Owning a house
Government services (police force, fire department, etc)
o However, no imputations for rent on other durables owned by the households (e.g., motor vehicles or jewelry)
o No imputations for cooking at home
o No imputations for goods and services sold at the underground economy (tax evasion or illegal activities)
o Imputed values are imperfect and make cross-country comparisons more difficult, but are less likely to affect time comparisons
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Real vs. Nominal GDP
How much is the GDP in the car-orange economy in the following year if the quantities sold of both goods stay the same, but their prices increase by 10 percent?
• Nominal GDP is measured at current prices
• Real GDP is measured at constant prices
Which one is a better measure of economic activity?
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How to Estimate Real GDP?
• Find the set of prices that prevailed in some particular year. The year in question is called a base year and the prices you identified are referred to as base-year prices
• The real GDP in any year is then obtained by valuing all final goods and services produced in the economy in that year at base-year prices.
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Example:
Let 2014 be our base year. Consider our car-orange economy.
Real GDP 2014 = (2014 price of cars × 2014 quantity of cars)
+ (2014 price of oranges × 2014 quantity of oranges)
Real GDP 2015 = (2014 price of cars × 2015 quantity of cars)
+ (2014 price of oranges × 2015 quantity of oranges)
Real GDP 2016 = (2014 price of cars × 2016 quantity of cars)
+ (2014 price of oranges × 2016 quantity of oranges)
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U.S. Nominal and Real GDP, $ billion
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GDP Deflator
GDP Deflator = 100 × Nominal GDP
Real GDP
• Note that dividing the nominal GDP by the GDP deflator and multiplying it by 100 will result in the real GDP. In other words, GDP deflator "deflates" the nominal measure of GDP into a real measure.
• GDP deflator is a measure of the overall price level in the economy relative to the base year. The price level in the base year is normalized to 100.
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Example 1: In an economy that produces only oranges, 10 million oranges are consumed. How much is the GDP deflator if the current orange price is $1.5 while its price in the base year was $1?
Example 2: In an economy that produces oranges and luxury cars, 10 million oranges and 2,000 cars are bought in some year. How much is the GDP deflator if the current orange price is $1.5 while its price in the base year was $1, and the current price of a car is $750,000 while its base-year price was $500,000?
Example 3: Everything is as in Example 2, but the current price of an orange, which is now $2. How much is the GDP deflator?
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Chain-Weighted Measures of Real GDP
• Over time, relative prices change
Example: the price of a year in college has risen, while the price of computers has fallen substantially in recent years
• Using outdated prices may be misleading
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• Solutions:
o Periodic update of prices by choosing a new base year
o Chain-weighted measure of real GDP
base year changes continuously
average prices in year t and year t+1 are used to measure the real GDP growth between year t and year t+1
forming a chain of annual growth rates that allows comparing real GDP at any two dates
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National Income Accounts Identity
• The value of aggregate output equals aggregate expenditure:
Y = C + I + G + NX
• C is consumption
• I is investment
• G is government purchases
• NX is net exports
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Components of Expenditure:
• Consumption is the value of the goods and services bought by households
o Nondurable goods last a short time, e.g., food, clothes, gasoline
o Durable goods last a long time, e.g., vehicles, household furnishings and equipment
o Services are intangible assets purchased by consumers, e.g., utilities, health care, recreation services, transportation services, financial services and insurance
Note: Renting a house enters consumption: spending on "housing services". Living in your own house is treated in the same way, i.e., consumption includes the imputed rental value of owner-occupied housing
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• Investment is the value of goods bought for future use
o Fixed investment
nonresidential: purchase of new plants and industrial, transportation, computer, etc. equipment
residential: purchase of new housing by households and landlords
intellectual property products: research and development (R&D) expenditures, software, entertainment, literary and artistic originals
o Change in private inventories: an increase in firms' inventories of goods (a decrease would result in a negative value)
Note: Investment does not reallocate existing assets, but creates a new physical asset, capital that can be used for future production
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• Government purchases include the goods and services bought by federal, state, and local governments, including military equipment. It also includes services provided by government workers and investment in structures (e.g., schools and highways), equipment, and software.
Note: Government purchases exclude transfer payments (e.g., unemployment insurance payments).
• Net exports measure the value of exports (goods and services sold to other countries) less the value of imports (goods and services bought from foreign countries).
Note: Net exports are expenditures from abroad that are income for domestic producers.
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GROSS DOMESTIC PRODUCT, 2015, billions of 2015 dollars 18,036.6 Personal consumption expenditures 12,283.7
Goods 4,012.1
Durable goods 1,355.2
Nondurable goods 2,656.9
Services 8,271.6
Gross private domestic investment 3,056.6
Fixed investment 2,963.2
Nonresidential 2,311.3
Structures 507.3
Equipment 1,086.1
Intellectual property products 717.9
Residential 651.9
Change in private inventories 93.4
Government consumption expenditures and gross investment 3,218.3
Federal 1,225.0
National defense 732.0
Nondefense 493.0
State and local 1,993.3
Net exports of goods and services –522.0
Exports 2,264.3
Imports 2,786.3 Source: U.S. Department of Commerce. Bureau of Economic Analysis
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GNP vs. GDP
• Gross national product (GNP): measures the total income earned by nationals (compare with GDP which measures the total income earned domestically)
GNP = GDP + Factor Payments from Abroad − Factor Payments to Abroad
Examples of factor payments: wages, profits, rent, interest and dividends on assets
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Country GNP, 2012, $ billion GDP, 2012,
$ billion GNP – GDP (% of GDP)
Bangladesh 127.7 116.4 9.7
Japan 6,150.1 5,961.1 3.2
China 8,185.0 8,227.1 -0.5
United States 16,514.5 16,244.6 1.7
India 1,837.3 1,858.7 -1.2
Canada 1,821.4 1,779.6 2.3
Greece 250.2 248.9 0.5
Iraq 216.5 215.8 0.3
Ireland 172.0 210.6 -18.3
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Seasonal Adjustment of Real GDP
• Real GDP follows a seasonal pattern
o A cycle that reaches a bottom in the first quarter and peaks in the fourth
o Reasons: weather, tastes, etc.
• Removing regular seasonal fluctuations
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2. CONSUMER PRICE INDEX
• What does it measure? The price of the basket of goods and services purchased by the typical consumer. In particular, it is the price of this basket relative to the price of the same basket in some base year multiplied by 100.
• Who estimates it? The Bureau of Labor Statistics (BLS) at the U.S. Department of Labor
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• Why not use the average price of all goods in the economy?
o Do you care more about the price of gasoline than about the price of a new Boeing airplane?
o The change of which prices would affect you most?
• Example: Suppose a typical consumer purchases 10 oranges, 5 grapefruits, and nothing else each month. If the base year is 2013, then
CPI = 100 ×
(10 × Current Price of Oranges) + (5 × Current Price of Grapefruits)
(10 × 2013 Price of Oranges) + (5 × 2013 Price of Grapefruits)
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15.1%
41.9%
3.5%
15.7% 7.7%
5.7% 3.3%
3.7% 3.4%
Food and bev.
Housing
Apparel
Transportation
Medical care
Recreation
Education
Communication
Other goods and services
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• Other price indexes:
o Producer price index (PPI) measures the price of the typical basket of goods bought by firms rather than consumers
o Price indexes for specific types of goods (e.g., food, housing, energy)
o Core inflation measures the increase in price of a consumer basket that excludes food and energy
o GDP deflator
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CPI vs. GDP Deflator
• CPI
o measures the prices of only the goods and services bought by consumers.
o includes imported goods as long as they enter the typical consumer's basket
o excludes capital goods
o assigns fixed weights to the prices of different goods (Laspeyres index)
• GDP deflator
o measures the prices of all goods and services produced
o only includes goods and services that are produced domestically
o includes capital goods
o assigns changing weights to the prices of different goods (Paasche index)
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CPI vs. GDP Deflator (continued)
• When relative prices of goods are changing, CPI which has a fixed basket
of goods will overstate the rise in the cost of living since it will ignore that consumers will substitute cheaper goods for more expensive ones thus changing the composition of the basket and mitigating the effects of price increases.
• When relative prices of goods are changing, the GDP deflator which has a changing basket of goods will understate the rise in the cost of living. While it will account for substitution of cheaper goods for more expensive one, it will ignore the loss of consumers' welfare that may result from such a substitution.
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PCE Deflator
• Personal Consumption Expenditures (PCE) deflator is another measure of the price level
• It is defined as the ratio of nominal to real consumer spending
• Similarly to CPI, the PCE deflator
o only includes consumer spending
o includes imported consumer goods
• Similarly to the GDP deflator, the “basket” of the PCE deflator changes over time
• The Federal Reserve prefers the PCE deflator.
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Inflation Rate
Source: https://research.stlouisfed.org/fred2/
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Problems with CPI
• CPI overstates increases in the cost of living
o Substitution bias (already discussed)
o Introduction of new goods increases variety and allows consumers to find products that more closely address their needs. In effect, the value of the dollar increases, but this is ignored by the CPI which uses a fixed basket of goods
o Unmeasured quality improvement: improvements in the quality of the goods in the basket increase the value of each dollar, but may not be easily measurable and so may be ignored by the CPI
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Problems with CPI (continued)
• The BLS has made technical adjustments, but the CPI probably still overstates inflation by about 0.5 percent per year.
• This is important because Social Security payments and many contracts have COLAs (cost of living adjustments) tied to the CPI.
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MIT Billion Prices Project
• Cavallo and Rigobon at MIT
• Collecting online prices
• Publishing daily price index
• US daily index closely tracks CPI, but this is not the case in Argentina
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US Daily Online Price Index
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Daily Index Official CPI
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3. UNEMPLOYMENT RATE
• What does it measure? The percentage of people who want to work, but do not have a job.
• Who estimates it? The Bureau of Labor Statistics (BLS) at the U.S. Department of Labor
• How often? Monthly
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The Household Survey
• 60,000 households approximately
• each adult (age 16 or older in each household):
o employed: paid employee, own business, unpaid employee in a family member's business, temporarily absent from his/her job due to vacation, illness, etc.
o unemployed: not employed, available for work, has attempted to find a job during the previous four weeks; also a person waiting to be recalled to a job from which he/she has been laid off
o not in labor force (e.g., full-time student, homemaker, retiree)
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Labor Force = Employed + Unemployed
Unemployment Rate = 100 × Unemployed / Labor Force
Labor-Force Participation Rate = 100 × Labor Force / Adult Population
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Employment Data, December 2016
• Civilian Population, age 16 or older: 254.74 million
• Civilian Labor Force: 159.64 million
• Employed: 152.11 million
• Unemployed: 7.53 million
• Not in Labor Force: 95.10 million
Unemployment Rate = (7.53 / 159.64) × 100 = 4.7%.
Labor-Force Participation Rate = (159.64 / 254.74) × 100 = 62.7%.
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• Trends in labor force participation:
o Economic factors (business cycles)
o Social changes: women vs. men
Growing labor force participation for women
• new technologies for household tasks
• improved birth control
• changes in political and social attitudes
Falling labor force participation for men
• young men stay longer in school
• older men retire earlier and live longer
• with more women employed, more stay-at home dads
o Demographics
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Source U.S. Dept. of Labor
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The Establishment Survey
• Approximately 160,000 business establishments with over 40 million workers on payroll
• The number of people who declare themselves employed in the household survey is positively correlated, but sometimes differs from the number of people who firms report as employed in the establishment survey
o self-employed
o people with two jobs
o employment at start-ups
o incorrect estimates of the population
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Employment Growth (Percent per Year)
Source: BLS
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CONCLUSION
• Statistics:
o GDP
o CPI
o Unemployment Rate
• From statistics to models and policy
