1 frank & bernanke 3 rd edition, 2007 ch. 5: ch. 5: measuring economic activity: gdp and...

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Frank & BernankeFrank & Bernanke33rdrd edition, 2007 edition, 2007

Ch. 5: Ch. 5: Measuring Economic Activity: GDP and Unemployment

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Why Measure A Nation’s Why Measure A Nation’s IncomeIncome

To have a sense of an economy’s size.To have a sense of an economy’s size. The well being of a citizen, on average, The well being of a citizen, on average,

depends on the nation’s income and its depends on the nation’s income and its population.population.

As the income of the society increases, the As the income of the society increases, the average person will have a higher standard average person will have a higher standard of living.of living.One can drown in a lake of 3-ft average depth.One can drown in a lake of 3-ft average depth.Standard of living may not necessarily be the Standard of living may not necessarily be the

goods and services a household can consume.goods and services a household can consume.

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Definition of GDPDefinition of GDP

Gross Domestic Product is the market value Gross Domestic Product is the market value of all the final goods and services produced of all the final goods and services produced within a country in a year.within a country in a year. How do you determine the value of child care?How do you determine the value of child care? How do you include the production of steel or How do you include the production of steel or

plastics?plastics? How do you include the sales of existing homes?How do you include the sales of existing homes? How do you account for $4 million paid at an How do you account for $4 million paid at an

auction for a Van Gogh painting?auction for a Van Gogh painting? How do you account for government services?How do you account for government services?

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Market ValueMarket Value Suppose we live in an economy where only Suppose we live in an economy where only

hamburgers, colas and cookies are hamburgers, colas and cookies are produced.produced.

Prices are: hamburgers $2; colas $1; Prices are: hamburgers $2; colas $1; cookies $0.50.cookies $0.50.

If this economy produces 100 hamburgers, If this economy produces 100 hamburgers, 150 colas and 200 cookies, what is the 150 colas and 200 cookies, what is the market value?market value?

What is the market value if 200 What is the market value if 200 hamburgers, 100 colas and 100 cookies hamburgers, 100 colas and 100 cookies are produced?are produced?

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Percentages of American Men and Women Percentages of American Men and Women over Age 16 Working Outside the Homeover Age 16 Working Outside the Home

• Increase in female labor force participation increases the demand for housekeeping and child care.

• Unpaid household work is not counted in GDP.• Paid household work is counted in GDP.• The increase in female labor force participation has overstated GDP growth.

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Gross Domestic Product: Gross Domestic Product: Measuring the Nation’s OutputMeasuring the Nation’s Output

Economic NaturalistEconomic NaturalistWhy has female participation in the labor Why has female participation in the labor

market increased by so much?market increased by so much?What explains the trends illustrated in the What explains the trends illustrated in the

previous figure?previous figure?Hint: The concept of comparative advantageHint: The concept of comparative advantage

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Why GDP Is Equal to Income?Why GDP Is Equal to Income?

How is my contribution to the US economy How is my contribution to the US economy calculated?calculated?The amount of educational service I create is The amount of educational service I create is

equal to my gross income.equal to my gross income.How is the income of a real estate agent How is the income of a real estate agent

calculated?calculated?When she sells a 25-yr old house, she gets a When she sells a 25-yr old house, she gets a

percent of the price as a payment for her percent of the price as a payment for her services.services.

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Why GDP Is Equal to Income?Why GDP Is Equal to Income?How is the GDP contribution of the How is the GDP contribution of the

textbook company calculated?textbook company calculated?After they pay the author, the paper company After they pay the author, the paper company

and the ink company, the amount of revenue and the ink company, the amount of revenue they get from textbook sales plus the value of they get from textbook sales plus the value of their book inventory (unsold books) is their book inventory (unsold books) is theirtheir contribution to the US GDP.contribution to the US GDP.

Their contribution is equal to wages, salaries, Their contribution is equal to wages, salaries, rent, interest and profits they pay.rent, interest and profits they pay.

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Value AddedValue Added

Calculate the contribution of the Calculate the contribution of the following activities to GDP.following activities to GDP.

Farmer sells cotton for $100.Farmer sells cotton for $100.Cotton is processed into thread and sold Cotton is processed into thread and sold

for $130.for $130.Thread is made into cloth and sold for Thread is made into cloth and sold for

$200.$200.Cloth is made into shirts and sold for Cloth is made into shirts and sold for

$300.$300.

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Circular FlowCircular Flow

HouseholdsFirms

Consumption expenditures of households

Income (wages, salaries, rent, interest, profit) earned by households

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Circular FlowCircular Flow

Upper flow is equal to GDP.Upper flow is equal to GDP.Lower flow is equal to income.Lower flow is equal to income. If GDP < Income, businesses will If GDP < Income, businesses will

reduce production and create less reduce production and create less income.income.

If GDP > Income, businesses will want If GDP > Income, businesses will want to expand production and create more to expand production and create more income.income.

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How Can We Measure GDP?How Can We Measure GDP?

Expenditure Approach: the upper flow.Expenditure Approach: the upper flow.

Y = C + I + G + NXY = C + I + G + NX Income Approach: the lower flow.Income Approach: the lower flow.

Y = Sum of factor incomesY = Sum of factor incomes

Y = Wages + Salaries + Rent + Interest + Y = Wages + Salaries + Rent + Interest + Profits Profits

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Components of Expenditure Components of Expenditure ApproachApproach

Consumption Consumption includes spending on includes spending on food, entertainment, shelter, health food, entertainment, shelter, health care, transportation, clothing, household care, transportation, clothing, household items, insurance, education.items, insurance, education.

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InvestmentInvestment includes purchases made by includes purchases made by firms to generate future income. firms to generate future income. Machinery, tools, buildings, trucks and Machinery, tools, buildings, trucks and cars are part of investment if they are cars are part of investment if they are bought to generate future income. By bought to generate future income. By convention, newly built houses and convention, newly built houses and inventory are included under investment.inventory are included under investment.

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Government purchasesGovernment purchases are expenditures are expenditures of federal, state and local governments on of federal, state and local governments on goods and services plus their payrolls.goods and services plus their payrolls.

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Net exports Net exports is exports minus imports.is exports minus imports.Dell Computer sales in China are part of Dell Computer sales in China are part of

US exports.US exports.Dell Computer purchases of plastic molds Dell Computer purchases of plastic molds

for their computers from China are part of for their computers from China are part of US imports.US imports.

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GDPGDP

http://www.bea.gov/bea/dn/nipaweb/TableView.asp#Mid

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Labor and Capital Income

Source: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=economic_indicators&docid=05de01.txt

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The Three Faces of GDPThe Three Faces of GDP

= =

Market Market value of value of

final final goods goods

and and servicesservices

Production Expenditure Income

InvestmentInvestment

ConsumptionConsumption

GovernmentGovernment

purchasespurchases

Net exportsNet exports

Capital Capital IncomeIncome

Labor IncomeLabor Income

= =

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A GDP Increase Always Increases A GDP Increase Always Increases The Size of the EconomyThe Size of the Economy

WRONG!WRONG!What if GDP in 2005 were 1000, in 2006 What if GDP in 2005 were 1000, in 2006

were 1500 but inflation was 50%?were 1500 but inflation was 50%? In this case, the increase in GDP is solely In this case, the increase in GDP is solely

attributable to price increases, not attributable to price increases, not improving the well being (standard of improving the well being (standard of living) of the average citizen.living) of the average citizen.

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Nominal vs. Real MeasuresNominal vs. Real Measures In macroeconomics, most variables are In macroeconomics, most variables are

measured in real terms, not nominal terms.measured in real terms, not nominal terms.Real variable eliminates the effect of Real variable eliminates the effect of

inflation.inflation.Nominal variable includes the effect of Nominal variable includes the effect of

inflation.inflation.GDP comparisons are always made with GDP comparisons are always made with

real GDP.real GDP.Nominal GDP uses current prices.Nominal GDP uses current prices.Real GDP uses base year prices. Real GDP uses base year prices.

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Real and Nominal GDPReal and Nominal GDP

The Economy Produces 2 Goods: Pizza and Soda

Year Pp Qp Ps Qs Nominal GDP Real GDP GDP Deflator

1997 10 1000 2 5000 $20,000.00 $20,000.00 100.01998 11 1000 3 6000 $29,000.00 $22,000.00 131.81999 13 1200 4 7000 $43,600.00 $26,000.00 167.7

Nominal GDP is calculated by adding the amounts spent on eachProduct. Real GDP is calculated by using the prices of pizza and Soda from 1997 o calculate the amounts spent in future years.GDP Deflator is Nominal GDP/Real GDP.

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Real and Nominal GDP

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What Is Wrong With Real GDP?What Is Wrong With Real GDP?

Real GDP increases if you sell your services Real GDP increases if you sell your services rather than provide them free.rather than provide them free.

If you build a house through Habitat for If you build a house through Habitat for Humanity your work doesn’t count as part of Humanity your work doesn’t count as part of GDP. If you get paid for the same work, it GDP. If you get paid for the same work, it counts.counts.

If you pollute during production and someone If you pollute during production and someone pays to clean the environment, the GDP will pays to clean the environment, the GDP will be higher than if the producer tried to reduce be higher than if the producer tried to reduce pollution during production so no clean-up pollution during production so no clean-up was necessary.was necessary.

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Underground EconomyUnderground Economy

If market transactions cannot be tracked If market transactions cannot be tracked by data collectors, they may be ignored.by data collectors, they may be ignored.

Transactions with high cash usage and Transactions with high cash usage and no paper trail can remain hidden from no paper trail can remain hidden from the government.the government.

GDP may actually be much higher than GDP may actually be much higher than government statistics if there is a large government statistics if there is a large underground economy.underground economy.

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Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being

Leisure TimeLeisure TimeShorter work weekShorter work weekStart working laterStart working laterRetire earlierRetire earlier

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Nonmarket Economic ActivitiesNonmarket Economic ActivitiesHousehold productionHousehold productionVolunteer servicesVolunteer servicesNonmarket activities are more important in Nonmarket activities are more important in

poor countriespoor countriesUnderground economyUnderground economy

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Environmental Quality and Resource Environmental Quality and Resource DepletionDepletionBenefits of environment quality are not Benefits of environment quality are not

measured.measured.GDP is not adjusted for resource depletion.GDP is not adjusted for resource depletion.

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Quality of LifeQuality of LifeCrime ratesCrime ratesTraffic congestionTraffic congestionCivic organizationsCivic organizationsOpen spaceOpen space

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Poverty and Economic InequalityPoverty and Economic InequalityGDP does not capture the effects of income GDP does not capture the effects of income

inequalityinequality

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GDP & Basic Indicators of Well-BeingGDP & Basic Indicators of Well-Being

IndicatorAll developing

countries

GDP per person 3,530 1,170 25,860(U.S. dollars)

Life expectancy at 64.5 51.7 78.0birth (years)

Infant mortality rate 61 100 6(per 1,000 live births)

Under-5 mortality rate 89 159 6(per 1,000 live births)

Doctors 78 30 252(per 100,000 people)

Incidence of HIV/Aids 1.3 4.3 0.3(% in 15-49 age group)

Undernourished 18 38 Negligiblepeople (%)

Primary enrollment 85.7 60.4 99.9rate (as % of age group)

Secondary enrollment 60.4 31.2 96.2rate (as % of age group)

Adult literacy rate (%) 72.9 51.7 98.6

Least developed countries

Industrialized countries

3333http://hdr.undp.org/hdr2006/statistics/

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How Does the Government Measure Unemployment?

• Bureau of Labor Statistics (Department of Labor) collects information every month.

• The first Friday of every month at 8:30 AM eastern time, the unemployment rate for the previous month is announced.

• People of age 16 and older are classified as either EMPLOYED or UNEMPLOYED or NOT IN THE LABOR FORCE.

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How Does the Government Measure Unemployment?

• Employed– Any one working for pay.– It may be full-time or part-time.

• Unemployed– Temporary lay-off.– Waiting to start a job.– Looking for a job.

• Not in the labor force– Retirees– Students– Homemakers– Inmates

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The Unemployment RateThe Unemployment Rate

Measuring UnemploymentMeasuring UnemploymentLabor force = employed + unemployedLabor force = employed + unemployed

force labor

unemployed rate ntUnemployme

over and 16 population

force labor rate ionParticipat

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U.S. Employment Data, U.S. Employment Data, July 2002 (in millions)July 2002 (in millions)

Employed 134.04

Plus:

Unemployed 8.35

Equals: Labor force 142.39

Plus:

Not in labor force 71.63

Equals:

Working-age (over 16) population 214.02

Unemployment rate = unemployed/labor force = 8.35/142.39 = 5.9%

Participation rate = labor force/working-age population = 142.39/214.02 = 66.5%

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http://stats.bls.gov/news.release/empsit.nr0.htm

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http://data.bls.gov/PDQ/servlet/SurveyOutputServlet

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The Cost of UnemploymentThe Cost of UnemploymentEconomicEconomicPsychologicalPsychologicalSocialSocial

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The Duration of UnemploymentThe Duration of UnemploymentThe impact of unemployment is influenced by The impact of unemployment is influenced by

how long individuals have been unemployed.how long individuals have been unemployed.The unemployment spellThe unemployment spellThe duration of unemploymentThe duration of unemploymentLong-term unemployedLong-term unemployedChronically unemployedChronically unemployed

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Unemployment SpellUnemployment SpellA period during which an individual is A period during which an individual is

continuously unemployedcontinuously unemployedDurationDuration

The length of an unemployment spellThe length of an unemployment spell

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The Duration of UnemploymentThe Duration of UnemploymentDiscouraged workersDiscouraged workers Involuntary part-time workersInvoluntary part-time workers In July 2002:In July 2002:

Official unemployment rate = 5.9%Official unemployment rate = 5.9%Including discouraged workers and involuntary Including discouraged workers and involuntary

part-time worker = 9.4%part-time worker = 9.4%

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Discouraged WorkersDiscouraged WorkersPeople who say they would like to have a job People who say they would like to have a job

but have not made an effort to find one in the but have not made an effort to find one in the last four weekslast four weeks

1 frank & bernanke 3 rd edition, 2007 ch. 5: ch. 5: measuring economic activity: gdp and...

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