Chapter Two 1

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CHAPTER 2The Data of Macroeconomics

A PowerPointTutorialTo Accompany

MACROECONOMICS, 7th. EditionN. Gregory Mankiw

Tutorial written by:Mannig J. Simidian

B.A. in Economics with Distinction, Duke University M.P.A., Harvard University Kennedy School of Government

M.B.A., Massachusetts Institute of Technology (MIT) Sloan School of Management

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Gross Domestic Product (GDP) is the dollar value of all final goods and services produced within an economy in a given period of time.

The consumer price index (CPI) measures the level of prices.

The unemployment rate tells us the fraction of workers who are unemployed.

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Gross Domestic Product is the best measure of how well the economy is performing. The Bureau of Economic Analysis (part of the U.S. Dept. of Commerce) calculates GDP via administrative data, which are byproducts of government functions such as tax collection, education programs, defense, and regulation, and statistical data, which come from government surveys of, for example, retail establishments manufacturing firms and farm activity.

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Two ways of viewing GDP

Total income of everyone in the economy

Total expenditure on the economy’s output of goods and services

Households Firms

Income $

Labor

Goods

Expenditure $

For the economy as a whole, income must equal expenditure. GDP measures the flow of dollars in the economy.

Income, Expenditure, And the Circular Flow

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1) To compute the total value of different goods and services, the national income accounts use market prices. Thus, if:

$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) The treatment of inventories depends on if the goods are stored orif they spoil. If the goods are stored, their value is included in GDP.If they spoil, GDP remains unchanged. When the goods are finally soldout of inventory, they are considered used goods (and are not counted).

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4) Intermediate goods are not counted in GDP– only the value offinal goods. Reason: the value of intermediate goods is already included in the market price. Value added of a firm equals the value of the firm’s output less the value of the intermediate goodsthe firm purchases.

5) Some goods are not sold in the marketplace and therefore don’thave market prices. We must use their imputed value as an estimateof their value. For example, home ownership and government services.

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The value of final goods and services measured at current prices is called nominal GDP. It can change over time, either because there is a change in the amount (real value) of goods and services or a change in the prices of those goods and services. Hence, nominal GDP Y = P y, where P is the price level and y is real output—and remember we use output and GDP interchangeably. Real GDP or, y = YP is the value of goods and services measured using a constant set of prices. This distinction between real and nominal can also be applied to other monetary values, like wages. Nominal (or money) wages can be denoted by W and decomposed into a real value (w) and a price variable (P). Hence, W = nominal wage = P • w

w = real wage = w/PThis conversion from nominal to real units allows us to eliminate the problems created by having a measuring stick (dollar value) that essentially changes length over time, as the price level changes.

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Let’s see how real GDP is computed in our apple and orange economy.

For example, if we wanted to compare output in 2009 and output in 2010, we would obtain base-year prices, such as 2009 prices. Real GDP in 2009 would be: (2009 Price of Apples 2009 Quantity of Apples) +(2009 Price of Oranges 2009 Quantity of Oranges).Real GDP in 2010 would be:(2009 Price of Apples 2010 Quantity of Apples) +(2009 Price of Oranges 2010 Quantity of Oranges).Real GDP in 2011 would be:(2009 Price of Apples 2011 Quantity of Apples) +(2009 Price of Oranges 2011 Quantity of Oranges).Note that 2009 prices are used to compute real GDP for all three years. Because prices are held constant from year to year, real GDP varies only when the quantities produced vary.

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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. Itreflects what’s happening to the overall level of prices in the economy.

GDP Deflator = Nominal GDP Real GDP

THE IMPLICIT PRICE DEFLATOR FOR GDP

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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. The base year changes continuously over time. This new chain-weighted

measure is better than the more traditional measure because it ensures that prices will not be

too out of date.

Average prices in 2009and 2010 are used to measurereal growth from 2009 to 2010.Average prices in 2010 and 2011are used to measure real growth from2010 to 2011, and so on. These growthrates are united to form a “chain” that isused to compare output between any twodates.

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Governmentpurchases of goods

and services

Y = C + I + G + NXY = C + I + G + NX

Total demandfor domestic output (GDP)

is composed of

Consumptionspending byhouseholds

Investmentspending by

businesses andhouseholds Net exports

or net foreigndemand

This is the called the national income accounts identity.

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GDP and Its Components

In 2007, U.S. GDP totaled about 13.8 trillion. This number is incomprehensible. So, if we divide this number by the total population of $302 million, we get GDP per person—the amount of expenditure for the average American– which equaled $45,707 in 2007. Let’s break it down visually on the next slide.

A Mankiw Macroeconomics

Case Study

Chapter Two

Consumption = $32,144

Investment = $7,052

Government Purchases =$8,854

Net Exports = $2,343

GDP (Y) was $45, 707 per personHere are the Components of Y in

2007:

Y = C + I + G + NXY = C + I + G + NX

$45,707 = $32,144 + $7,052 + $8,854 + $2,343$45,707 = $32,144 + $7,052 + $8,854 + $2,343

Remember that thesecalculations are performed per person just forcomprehensionpurposes.

Note: The numbers above must be multipliedmultiplied by the U.S. Population 302 million to obtain the totals for the above national income accounts identity Y = C + I + G + NX.

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To see how the alternative measures of income relate to one another, we start with GDP and add or subtract various quantities.To obtain gross national product (GNP), we add receipts of factorincome (wages, profit, and rent) from the rest of the world andsubtract payments of factor income to the rest of the world.GNP = GDP + Factor Payments from Abroad - Factor Payments to AbroadWhereas GDP measures the total income produced domestically, GNPmeasures the total income earned by nationals (residents of a nation).To obtain net national product (NNP), we subtract the depreciation ofcapital—the amount of the economy’s stock of plants, equipment, andresidential structures that wears out during the year:

NNP = GNP – DepreciationIn the national income accounts, depreciation is called the consumptionof fixed capital. It equals about 10% of GNP. Because depreciation ofcapital is a cost of producing the output of the economy, subtracting

depreciation shows the net result of economic activity.

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Net National is approximately equal to another measure called national income. The two differ by a small correction called the statistical discrepancy, which arises because different data sources may not be completely consistent.

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The Consumer Price Index (CPI) turns the prices of many goods and services into a single index

measuring the overall level of prices. The Bureau of Labor Statistics weighs different items by computing the price of a basket of goods and

services produced by a typical customer. The CPI is the price of this basket of goods relative to the

price of the same basket in some base year.

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Let’s see how the CPI would be computed in ourapple and orange economy.

For example, suppose that the typical consumer buys 5 apples and 2 oranges every month. Then the basket of goods consists of 5 apples and 2 oranges, and the CPI is:

CPI = ( 5 Current Price of Apples) + (2 Current Price of Oranges)

( 5 2009 Price of Apples) + (2 2009 Price of Oranges)

In this CPI calculation, 2009 is the base year. The index tells how much it costs to buy 5 apples and 2 oranges in the current year relative to how much it cost to buy the same basket of fruit in 2009.

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This statistic measures the increase in the price of a consumer basket that excludes food and energy products. Because food and energy prices exhibit substantial short-run volatility, core inflation is sometimes viewed as a better gauge of ongoing inflation trends.

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The GDP deflator measures the prices of all goods produced, whereas the CPI measures prices of only the goods and services bought by consumers. Thus, an increase in the price of goods bought only by firms or the government will show up in the GDP deflator, but not in the CPI.

Also, another difference is that the GDP deflator includes only those goods and services produced domestically. Imported goods are not a part of GDP and therefore don’t show up in the GDP deflator.

The final difference is the way the two aggregate the prices in the economy. The CPI assigns fixed weights to the prices of different goods, whereas the GDP deflator assigns changing weights.

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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

100

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The Bureau of Labor Statistics (BLS) computes these statistics for theoverall population and for groups within the population: menand women, whites and blacks, teenagers and prime-age workers. In2008, the statistics broke down as follows:Labor Force = 145.0 + 10.1 = 155.1 million

Unemployment rate = (10.1/155.1) x 100 = 6.5%

Labor-Force Participation Rate = (155.1/234.6) x 100 = 66.1%

Hence, about two-thirds of the adult population was in the labor force,and about 6.5 percent of those in the labor force did not have a job.

The BureauLaborStatisticsLabor Force = 147.4 million

Unemployment rate = 5.5%

Labor Force Participation Rate = 66.0%

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The BLS conducts two surveys of labor market, and therefore produces two measures of total

employment. The establishment survey estimates the number of workers firms have on their payrolls.The household survey estimates the number of people who say they are working.

Two measures of employment are not necessarily identical, although positively correlated. The reason? The surveys measure different things and the surveys in general, are imperfect.

Some economists believe that the establishment survey is more accurate because it has a larger sample size. Bottom line: all economic statistics are imperfect!

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National income accounts identity Consumption Investment Government purchases

Net exports Labor force Labor-force participation rate

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