Introduction to Macroeconomics

Chapter 4

Measuring Output of the Macroeconomy

Introduction to Macroeconomics

Chapter 4. Measuring the Macroeconomy

1. Measuring Total Output2. How to Measure GDP3. GDP Accounting Complications4. Nominal and Real GDP5. Measuring Price Changes6. Empirical Applications

Introduction to Macroeconomics

1. Measuring Total Output

• Monetary Measure of Value

• GDP versus GNP

• Omissions from GDP - does not measure social welfare

Introduction to Macroeconomics

1. Measuring Total Output Monetary Measure of Value

Quantity times Price equals Market Value

Cars 1,000 x $20,000 = $20,000,000

Dolls 10,000 x $ 10 = $ 100,000

Total Value of Output = $20,100,000

Introduction to Macroeconomics

1. Measuring Total Output GDP versus GNP

• Nominal Gross Domestic Product (GDP) - the market value of final goods and services (i.e., sold to final consumers) produced by a nation during a specific period, usually 1 year.

• Nominal Gross National Product (GNP) - the market value of final goods and services produced by labor and property supplied by the residents of a nation during a specific period, usually 1 year.

Introduction to Macroeconomics

1. Measuring Total Output Omissions from GDP

GDP is a poor measure of social welfare:• Leisure• Home and volunteer labor

(non market production)• Depletion of nonrenewable resources• Unregulated pollution• Distribution of income• Differences in preferences

Introduction to Macroeconomics

2. How to Measure GDP

• Circular Flow

• Expenditure Approach

• Income Approach

Introduction to Macroeconomics

2. How to Measure GDP Circular Flow of Income and Expenditures

Households BusinessFirms

Resources

Income

Goods and Services

Expenditures

Solid Lines - Flow of MoneyDashed lines - Flow of Goods and Services

Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach

• GDP = Consumption Spending (C)

+ Private Domestic Investment (I)

+ Government Spending (G)

+ Exports - Imports (net exports, NX)

• GDP = C + I + G + NX

Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Expenditure Shares

Consumption69.9 %

Government Spending18.8 %

Investment15.2 %

2002 U.S. Nominal Gross Domestic Product

Net Exports = - 4.1 % (not shown in slide)

Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Consumption

40%

45%

50%

55%

60%

65%

70%

75%

1959 1969 1979 1989 1999

Per

cen

t o

f G

DP

U.S.

Japan

1999U.S. 68.2 %Japan 60.1 %

Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Government

0%

5%

10%

15%

20%

25%

30%

35%

1959 1969 1979 1989 1999

Per

cen

t o

f G

DP

U.S.

Japan

1999U.S. 17.6 %Japan 18.4 %

Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Investment

0%

5%

10%

15%

20%

25%

30%

35%

1959 1969 1979 1989 1999

Per

cen

t o

f G

DP

U.S.

Japan

1999U.S. 17.9 %Japan 20.0 %

Introduction to Macroeconomics

2. How to Measure GDP Expenditure Approach: Net Exports

-6%

-4%

-2%

0%

2%

4%

6%

1959 1969 1979 1989 1999

Per

cen

t o

f G

DP

U.S.

Japan

1999U.S. - 3.7 %Japan 1.5 %

Introduction to Macroeconomics

2. How to Measure GDP Income Approach

• National Income = GDP (with corrections)

• Personal Income = National Income (with corrections)

• Personal Income - Personal income taxes - Social Security withholding = Disposable Personal Income

Introduction to Macroeconomics

3. GDP Accounting Complications

• Double Counting

• Depreciation

Introduction to Macroeconomics

3. GDP Accounting Complications Double Counting

• Intended for “final” use– excludes intermediate products

• Value Added– excludes used goods

Introduction to Macroeconomics

3. GDP Accounting Complications Depreciation

Gross Investment

- Depreciation

= Net Investment

Gross Domestic Product (GDP)

- Depreciation

= Net Domestic Product (NDP)

Introduction to Macroeconomics

4. Nominal and Real GDP

• Definitions

• Sample Problem

• GDP Growth

Introduction to Macroeconomics

4. Nominal and Real GDP Definitions

• Nominal GDP– Value of output measured at actual prices

(current dollar output)– Does not correct for inflation

• Real GDP– Value of output based on prices of some base

period (“constant” dollar output)– eliminates effect of inflation

Introduction to Macroeconomics

4. Real GDP Sample Problem

Average Prices Quantity Sold

1992 1994 % Change 1992 1994

Food $ 12 $ 14 17 % 4 5

Housing 9 10 11 % 3 3

Fun 4 5 25 % 3 4

Machines 20 20 0 % 2 2

Introduction to Macroeconomics

4. Real GDP Definition of Nominal GDP

Nominal GDP

= Current year Quantities

x Current year Prices

Introduction to Macroeconomics

4. Real GDP Sample Problem: 1992 Nominal GDP

= 1992 Quantities x 1992 Prices

= 1992 Spending onFood Housing Fun Machines

= 4 • $12 + 3 • $9 + 3 • $4 + 2 • $20

= $48 + $27 + $12 + $40

= $127

Introduction to Macroeconomics

4. Real GDP Sample Problem: 1994 Nominal GDP

= 1994 Quantities x 1994 Prices

= 1994 Spending onFood Housing Fun Machines

= 5 • $14 + 3 • $10 + 4 • $5 + 2 • $20

= $70 + $30 + $20 + $40

= $160

Introduction to Macroeconomics

4. Real GDP Definition of Real GDP

Real GDP

= Current year Quantities

x Base year Prices

Introduction to Macroeconomics

4. Real GDP Sample Problem: 1992 Real GDP

= 1992 Quantities x 1992 Prices

Food Housing Fun Machines

= 4 • $12 + 3 • $9 + 3 • $4 + 2 • $20

= $48 + $27 + $12 + $40

= $127

Introduction to Macroeconomics

4. Real GDP Sample Problem: 1994 Real GDP

= 1994 Quantities x 1992 Prices

Food Housing Fun Machines

= 5 • $12 + 3 • $9 + 4 • $4 + 2 • $20

= $60 + $27 + $16 + $40

= $143

Introduction to Macroeconomics

4. Real GDP Sample Problem: GDP Growth

• Growth in Nominal GDP= (160 - 127) • 100 = 26%

127

• Growth in Real GDP= (143 - 127) • 100 = 13%

127

Introduction to Macroeconomics

5. Measuring Price Changes

• Price index

• GDP deflator

• Consumer price index

• Problems with price indexes

Introduction to Macroeconomics

5. Measuring Price ChangesPrice indexes

• Price Index: a measure of the change in the average level of prices

• GDP Deflator– Base-year prices– Quantities variable– Imports excluded

• Consumer Price Index– Base year quantities– Prices variable– Imports included

Introduction to Macroeconomics

5. Measuring Price ChangesGDP deflator

GDP Deflator = Nominal GDP • 100

Real GDP

1992 GDP Deflator = 127• 100 = 100.0

127

1994 GDP Deflator = 160 • 100 = 111.9

143

Introduction to Macroeconomics

5. Measuring Price ChangesInflation

Change in Average Level of Prices

= Percent Change in GDP Deflator

Inflation from 1992 to 1994

= (1994 Deflator - 1992 Deflator) • 100

1992 Deflator

= (111.9 - 100.0) • 100 = 11.9%

100.0

Introduction to Macroeconomics

5. Measuring Price ChangesProblems with price indexes

• Substitution bias - changes in relative prices– between goods (butter vs margarine)– between stores (small vs large discounters)

• Quality changes and new products

• Chain-weighted indexes

Introduction to Macroeconomics

6. Empirical Applications

• Use Real rather than Nominal values

• Compare Per Capita rather than Aggregates

• Compare Growth Rates rather than Levels

Introduction to Macroeconomics

6. Empirical Applications Compare Per Capita rather than Aggregates

Real GDP Per Capita, 1929 - 2002

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

1929 1939 1949 1959 1969 1979 1989 1999

Ch

ain

ed

19

96

Do

llars

Source: Bureau of Economic Analysis (www.bea.doc.gov)

Introduction to Macroeconomics

6. Empirical Applications Compare growth rates rather than levels

10-year Changes in Real GDP Per Capita

0.59%

4.59%

2.39%

3.03%

2.19% 2.05%1.78%

0%

1%

2%

3%

4%

5%

1930-1939

1940-1949

1950-1959

1960-1969

1970-1979

1980-1989

1990-1999

An

nu

al A

ve

rag

e P

erc

en

t C

ha

ng

e

Source: Bureau of Economic Analysis (www.bea.doc.gov)