iii the data of macroeconomics

III THE DATA OF MACROECONOMICS

5Measuring a Nation’s

Income

Microeconomics and Macroeconomics

• Microeconomics is the study of how individual households and firms make decisions and how they interact with one another in markets

• Macroeconomics is the study of the economy as a whole• Its goal is to explain the economic changes that

affect many households, firms, and markets at once

CHAPTER 5 MEASURING A NATION’S INCOME

Macroeconomics

• Macroeconomics answers questions like these:• Why is average income high in some countries and

low in others? • Why do prices rise rapidly in some time periods

while they are more stable in others? • Why do production and employment expand in

some years and contract in others?


The Role of Data

• To see whether there’s a problem, you first need data

The Role of Data

• In macroeconomics, data is crucial1. Data helps policy makers see what problems,

if any, need to be addressed2. Data helps macroeconomists identify the

theories that make correct predictions and the theories that make incorrect predictions

3. Data often reveals interesting puzzles that macroeconomic theories need to solve


Total Income

• When judging whether an economy is doing well or poorly, it is natural to look at the total income that everyone in the economy is earning


Total Income

• We can temporarily boost our standard of living by borrowing from others.

• But we can’t keep borrowing forever• This is why a nation’s standard of living

depends heavily on its own total income


Income = Expenditure

• We could measure either total income or total expenditure• We will get the same number either way

• For an economy as a whole, income must equal expenditure because:• Every transaction has a buyer and a seller.• Every dollar of spending by some buyer is a dollar

of income for some seller.


But what about saving?

• Q: People typically save part of what they earn. How then is income equal to expenditure for the economy as a whole?

• A: What people save tends to be loaned to businesses who then spend what they borrowed.



International Trade

• We buy foreign-made goods and foreigners buy goods made by us

• Q: In that case, how can our total income be equal to our total expenditure?

• A: Very good point! It is better to say that total income equals the total expenditure on domestically produced goods

GROSS DOMESTIC PRODUCT


Gross Domestic Product

• Gross Domestic Product (GDP) is one measure of a country’s total income• There are other measures



• GDP is the total market value of all final goods and services produced within a country in a given period of time.• For example, the GDP of the United States in 2014

was $ 17,348.1 billion, according to the U.S. Department of Commerce

• Given a mid-year population of 319,173,000 (est.) the per capita GDP was $ 54,353 in 2014

http://bea.gov/national/index.htm


• We just saw that GDP is the total market value of all final goods and services produced

• Therefore, GDP is also the total expenditure on all final goods and services produced

• As expenditure on final goods is equal to income, GDP is also total income


“Final” Goods and Services

• Final goods are those goods sold to their final users

• A pencil is a final good because, once produced, it is ready for use by its final users

• The wood, the graphite, and other materials that disappeared in the pencil are not final goods• Their market value is already counted when the

market value of the pencil is counted• So, counting them in GDP would count them twice

GDP is the Market Value …

• In GDP, all output is valued at market prices.• The market value of all sandwiches produced is

both the total expenditure of the buyers of those sandwiches and the total income of the makers of those sandwiches

• As our goal is to measure total income, it therefore makes sense to measure the market values of the various produced goods and add them up


… Of All Final Goods …

• GDP records only the value of final goods, not intermediate goods • Intermediate goods are those goods that disappear

inside other goods that are produced for sale• Final goods are goods that are not intermediate

goods. These are goods sold to their final users• GDP is defined so that the value of

intermediate goods is counted only once, not twice or thrice.


… Of All Final Goods …

• Intermediate goods are sold by their producers to producers of other goods• Examples: milk sold by a dairy to an ice-cream company,

grapes sold by a vineyard to a winemaker, printer paper sold to Kinko’s

• Final goods are goods that are sold to the final users of those goods• Examples: milk you buy at the supermarket, table grapes

you buy at the farmer’s market, printer paper you buy for your computer printer

• All goods made this year but not sold by year’s end are regarded as final goods (inventories)


… and Services …

• GDP includes both • tangible goods (food, clothing, cars) and • intangible services (haircuts, housecleaning, doctor

visits, legal consultations). • Trade in assets does not affect GDP.

• Such trade does not require new productive activity, it is merely the transfer of ownership of an asset from one person to another


… Produced Within a Country …

• GDP measures the value of all production within the geographic boundaries of a country.

• The citizenship of the owners of the resources used in production is not the key issue

• Production by foreigners living in a country is counted in the country’s GDP

• Production by a country’s citizens working in other countries is not counted


… In a given period of time

• GDP measures the value of production that takes place within a specific interval of time, usually a year or a quarter (three months).

• GDP includes goods and services currently produced, not transactions involving goods produced in the past.• Transactions involving used cars or buildings that

were constructed in the past are not counted


What’s not counted in GDP?

• GDP includes all items produced in the economy and sold legally in markets.• It excludes items produced and sold illicitly, such as

illegal drugs.• GDP excludes most items that are produced

and consumed at home and that never enter the marketplace.


What is Gross Domestic Product (GDP)?

• Video: https://youtu.be/mjJmo5mN5yA


https://youtu.be/mjJmo5mN5yA

https://youtu.be/mjJmo5mN5yA

NOMINAL AND REAL GDP

How can we measure a nation’s productive activity so that the numbers can be compared across time?

GDP: nominal and real

• The GDP we saw earlier is more precisely called Nominal GDP

• GDP comes in two flavors:• Nominal GDP (also called GDP at current prices),

and• Real GDP (also called GDP at constant prices)

• So, when you see or hear a discussion of GDP, be sure to ask, “Nominal or real?”

Nominal and Real GDP

Apples OrangesPrice ($) Quantity Price ($) Quantity

2012 50 10 20 502013 100 20 30 1002014 150 20 50 200

Nominal GDP $2012 ($50 ✕ 10) + ($20 ✕ 50) = 15002013 ($100 ✕ 20) + ($30 ✕ 100) = 50002014 ($150 20) + ($50 200) =✕ ✕ 13000

Real GDP (Base year 2012) 2012 $2012 ($50 10) + ($20 50) =✕ ✕ 15002013 ($50 ✕ 20) + ($20 ✕ 100) = 30002014 ($50 20) + ($✕ 20 200) =✕ 5000

Note that the base year’s nominal and real GDP must be the same.



2012 50 10 20 502013 100 20 30 1002014 150 20 50 200

Nominal GDP $2012 ($50 ✕ 10) + ($20 ✕ 50) = 15002013 ($100 ✕ 20) + ($30 ✕ 100) = 50002014 ($150 20) + ($50 200) =✕ ✕ 13000

Real GDP (Base year 2012) 2012 $2012 ($50 10) + ($20 50) =✕ ✕ 15002013 ($50 ✕ 20) + ($20 ✕ 100) = 30002014 ($50 20) + ($✕ 20 200) =✕ 5000

Inflation makes it impossible to meaningfully compare Nominal GDP across the years

Real GDP takes inflation out of the picture, thereby making the numbers comparable over time. These numbers are changing from one year to the next entirely because of changes in production



2012 50 10 20 502013 100 20 30 1002014 150 20 50 200

Nominal GDP $ Growth Rate (%)2012 ($50 10) + ($✕ 20 50) =✕ 15002013 ($100 20) + ($30 100) =✕ ✕ 5000 100 [(5000 – 1500)/ 1500] = 233 ✕2014 ($150 20) + ($50 200) =✕ ✕ 13000 100 [(13000 – 5000)/ 5000] = 160✕

Real GDP (Base year 2012) 2012 $2012 ($50 10) + ($✕ 20 50) =✕ 15002013 ($50 20) + ($✕ 20 100) =✕ 3000 100 [(3000 – 1500)/ 1500] = 100✕2014 ($50 20) + ($✕ 20 200) =✕ 5000 100 [(5000 – 3000)/ 3000] = 67✕

100 valueOld

valueOld valueNewRateGrowth

Nominal vs. Real GDP

• Video: https://youtu.be/rGqhTQyY6g4


https://youtu.be/rGqhTQyY6g4

https://youtu.be/rGqhTQyY6g4

Real and Nominal GDP of USA

Growth Rate of Real GDP, USA

• http://research.stlouisfed.org/fred2/series/GDPCA

The gray bars indicate recessions; the beginning and end of each US recession is determined by the National Bureau of Economic Research’s Business Cycle Dating Committee. See http://www.nber.org/cycles/recessions.html

http://research.stlouisfed.org/fred2/series/GDPCA

http://www.nber.org/cycles/recessions.html

http://www.nber.org/cycles/recessions.html

Real GDP and Potential Real GDP

Table 2: Real and Nominal GDP

This table shows how to calculate real GDP, nominal GDP, and the GDP deflator for a hypothetical economy that produces only hot dogs and hamburgers.

The GDP Deflator

• The GDP deflator is a measure of the overall level of the prices of the final goods and services produced within a country during a given period of time


The GDP Deflator

• The GDP Deflator tells us how much of the rise in nominal GDP over a period of time is attributable to a rise in prices (rather than a rise in the quantities produced).


The GDP Deflator

• The GDP Deflator is calculated as follows:


Example: 2013

• US Nominal GDP was $16,803.0 billion• US Real GDP was $15,767.1 billion (chained

2009 dollars)• US GDP Deflator = (16,803.0/15,767.1) × 100 =

106.57• This means that, roughly, final goods and services

were on average 6.57% pricier in 2013 compared with 2009


The GDP Deflator

• Why call it a deflator?• Nominal GDP changes from one year to the

next partly because of inflation• Real GDP, on the other hand, changes because

of changes in production alone• The GDP Deflator can convert Nominal GDP to

Real GDP by deflating the effect of inflation in Nominal GDP


Converting Nominal GDP to Real GDP

• We just saw that

• Therefore,

• Therefore, if you know the Nominal GDP and the GDP Deflator, you can calculate the Real GDP


THE COMPONENTS OF GDP


Components of GDP

• We need to pay attention not only to the total expenditure on all final goods and services made in a country (GDP), we also need to watch where the expenditure is coming from

• That way, when there’s a recession, we’ll know which sector needs the most attention

• GDP = Consumption Spending + Investment Spending + Government Spending + Exports – Imports

Components of GDP

• GDP = Consumption Spending + Investment Spending + Government Spending + Exports – Imports

• Q: Why do we subtract imports?• A: GDP is the market value of all final “Made in

USA” goods. But consumption, investment, and government spending all include foreign goods. Therefore, to make the two sides of the equation the same, we must take out all the hidden imports.

Table 1: GDP and Its Components

This table shows total GDP for the U.S. economy in 2012 and the breakdown of GDP among its four components. When reading this table, recall the identity Y = C + I + G + NX.

45

GDP and Components, USA

Real GDP and Components, USA

GDP and Real GDP per capita, USA

The Components Of GDP

• Consumption (C):• The spending by households on goods and services,

with the exception of purchases of new housing.• Investment (I):

• The spending on capital equipment, inventories, and structures, including new housing.


The Components Of GDP

• Government Purchases (G):• The spending on goods and services by local, state,

and federal governments.• Does not include transfer payments because they

are not made in exchange for currently produced goods or services.

• Net Exports (NX):• Exports minus imports.


Splitting GDP

• Video: https://youtu.be/ChnRwedmO64


https://youtu.be/ChnRwedmO64

https://youtu.be/ChnRwedmO64

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

Consumption, percent of real GDP



1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

Investment, percent of real GDP


1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

Government Spending, percent of real GDP


1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

EXIM

U.S. Exports and Imports, as a percentage of real GDP

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020

-7.00

-6.00

-5.00

-4.00

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

Net Exports, percent of real GDP


Where to find US data

• Bureau of Economic Analysis, U.S. Department of Commerce: http://bea.gov

• Federal Reserve Bank of St. Louis: http://research.stlouisfed.org/fred2/categories/18


http://bea.gov/

http://research.stlouisfed.org/fred2/categories/18

http://research.stlouisfed.org/fred2/categories/18

INTERNATIONAL GDP COMPARISONS

How can we measure national productive activity so that the numbers can be compared across nations?

International Comparisons

• When the GDP numbers for various countries’ are compared, the same currency units must be used

• There are two ways of converting from national countries to a common currency, such as the US dollar• Use market exchange rates• Use a common set of prices (PPP)

Market Exchange Rate Method

• Step 1: Look up Mexico’s GDP in Mexico’s currency, the peso

• Step 2: Look up how many US dollars one Mexican peso is worth

• Step 3: Multiply the numbers in Steps 1 and 2• This gives you Mexico’s GDP in US dollars• When the GDPs of two countries are both

expressed in US dollars, they can be compared head to head

Purchasing Power Parity Method

• Step 1: Find out the quantities of all the final goods that were produced in Mexico during 2015

• Step 2: Find out the prices of those goods in the United States—not Mexico—in 2015. • These prices are in US dollars

• Step 3: Calculate Mexico’s GDP in US dollars, by• Step 3a: multiplying the quantities in Step 1 by the

corresponding prices in Step 2 and • Step 3b: then adding the results obtained in Step 3a

Continuation of Previous Slide

Downloaded from http://databank.worldbank.org/databank/download/GDP.xls and http://databank.worldbank.org/databank/download/GDP_PPP.xls on November 14, 2012.

http://databank.worldbank.org/databank/download/GDP.xls

http://databank.worldbank.org/databank/download/GDP.xls

http://databank.worldbank.org/databank/download/GDP_PPP.xls



Gross National Product

• There’s another measure of national income called Gross National Product

• GNP = GDP + income earned by domestic residents from

foreign residents – income paid to foreign residents by domestic

residents• Gross National Product is theoretically the same as

Gross National Income (GNI)• The next slide compares GNI per capita in 2011 for various

countries

Per Capita International ComparisonsSource: http://databank.worldbank.org/databank/download/GNIPC.xls

http://databank.worldbank.org/databank/download/GNIPC.xls


Per Capita International ComparisonsSource: http://databank.worldbank.org/databank/download/GNIPC.xls

As in the previous slide, these numbers are measures of Gross National Income per capita, in international dollars using the PPP method



Basic Facts of Wealth

• Video: https://youtu.be/PzAr_mL0Qd8


https://youtu.be/PzAr_mL0Qd8

https://youtu.be/PzAr_mL0Qd8

IS GDP A GOOD MEASURE OF ECONOMIC WELL-BEING?

No, but it is the best one-number measure we have


There’s a lot that’s missing in GDP

• Where to begin!• Inequality, work done in home, volunteer work,

illegal work, leisure, environment, disasters, …

Source: https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/presentation/50318-taxesspending.pdf

https://www.cbo.gov/sites/default/files/114th-congress-2015-2016/presentation/50318-taxesspending.pdf



There’s inequality even among the rich!



Source: Understanding the Historic Divergence Between Productivity and a Typical Worker’s Pay: Why It Matters and Why It’s Real, By Josh Bivens and Lawrence Mishel | September 2, 2015. URL: http://www.epi.org/publication/understanding-the-historic-divergence-between-productivity-and-a-typical-workers-pay-why-it-matters-and-why-its-real/

http://www.epi.org/people/josh-bivens

http://www.epi.org/people/josh-bivens

http://www.epi.org/people/lawrence-mishel

http://www.epi.org/people/lawrence-mishel

http://www.epi.org/publication/understanding-the-historic-divergence-between-productivity-and-a-typical-workers-pay-why-it-matters-and-why-its-real/



Leisure Reduces GDP

GDP Doesn’t Count Illegal Work

Jesse: “All this hard work, Mr. White! What’s the point? They won’t even count it in GDP!”

GDP Doesn’t Count Work at Home

GDP Doesn’t Count Volunteer Work

GDP Ignores Environmental Damage

GDP Ignores Consumer Surplus

• Free digital technology• Free Apps, Google, Google maps, Wikipedia,

OpenOffice, YouTube• Freely available education

• Khan Academy, Coursera

• None of this adds to GDP• Users would be willing to pay but don’t. They

get Consumer SurplusCHAPTER 5 MEASURING A NATION’S INCOME

GDP And Economic Well-being

• GDP is the best single measure of the economic well-being of a society.

• GDP per person tells us the income and expenditure of the average person in the economy.


Table 3: GDP and the Quality of Life

The table shows GDP per person and three other measures of the quality of life for twelve major countries.

84

Robert Kennedy on GDP

• [Gross Domestic Product] does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud that we are Americans.


Real GDP Per Capita and the Standard of Living

• Video: https://youtu.be/Z0qHA93oOSc


https://youtu.be/Z0qHA93oOSc

https://youtu.be/Z0qHA93oOSc


Any questions?

Summary

• Because every transaction has a buyer and a seller, the total expenditure in the economy must equal the total income in the economy.

• Gross Domestic Product (GDP) measures an economy’s total expenditure on newly produced goods and services and the total income earned from the production of these goods and services.


Summary

• GDP is the market value of all final goods and services produced within a country in a given period of time.

• GDP is divided among four components of expenditure: consumption, investment, government purchases, and net exports.


Summary

• Nominal GDP uses current prices to value the economy’s production. Real GDP uses constant base-year prices to value the economy’s production of goods and services.

• The GDP deflator—calculated from the ratio of nominal to real GDP—measures the level of prices in the economy.


Summary

• GDP is a good measure of economic well-being because people prefer higher to lower incomes.

• It is not a perfect measure of well-being because some things, such as leisure time and a clean environment, aren’t measured by GDP.


iii the data of macroeconomics

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