U.S. Gross Domestic Product in billions of chained 1996 dollars

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U.S. Gross Domestic Product in billions of
chained 1996 dollars
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Real vs. Nominal GDP

• GDP is the value of all final goods and services
  produced.
• Nominal GDP measures these values using current
  prices.
• Real GDP measure these values using the prices of
  a base year.

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Real GDP controls for inflation

• Changes in nominal GDP can be due to
• changes in prices
• changes in quantities of output produced
• Changes in real GDP can only be due to changes in
  quantities,
• because real GDP is constructed using constant
  base-year prices.

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U.S. Real Nominal GDP, 1967-2001
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How the BLS constructs the CPI

1. Survey consumers to determine composition of the
   typical consumers basket of goods.
2. Every month, collect data on prices of all items
   in the basket compute cost of basket
3. CPI in any month equals

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Exercise Compute the CPI

• The basket contains 20 pizzas and 10 compact
  discs.

prices pizza CDs 2000 10 15 2001 11 15 2002
12 16 2003 13 15

• For each year, compute
• the cost of the basket
• the CPI (use 2000 as the base year)
• the inflation rate from the preceding year

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answers

• cost of inflation
• basket CPI rate
• 2000 350 100.0 n.a.
• 2001 370 105.7 5.7
• 2002 400 114.3 8.1
• 2003 410 117.1 2.5

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The composition of the CPIs basket
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GDP Deflator

• The inflation rate is the percentage increase in
  the overall level of prices.
• One measure of the price level is the GDP
  Deflator, defined as

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Two measures of inflation
Percentage
change
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14

12

10

8

6

4

2

0

2
-
1948
1953
1958
1963
1968
1973
1978
1983
1988
1993
1998
Year
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Okuns Law

• Employed workers help produce GDP, while
  unemployed workers do not. So one would expect
  a negative relationship between unemployment and
  real GDP.
• This relationship is clear in the data

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Okuns Law
Okuns Law states that a one-percent decrease in
unemployment is associated with two percentage
points of additional growth in real GDP
Percentage change in real GDP
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1951
1984
2000
1999
1993
1975
1982
Change in unemployment rate
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Marginal product of labor (MPL)

• defThe extra output the firm can produce using
  an additional unit of labor (holding other inputs
  fixed)
• MPL F (K, L 1) F (K, L)

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Exercise compute graph MPL

• L Y MPL
• 0 0 n.a.
• 1 10 ?
• 2 19 ?
• 3 27 8
• 4 34 ?
• 5 40 ?
• 6 45 ?
• 7 49 ?
• 8 52 ?
• 9 54 ?
• 10 55 ?

1. Determine MPL at each value of L
2. Graph the production function
3. Graph the MPL curve with MPL on the vertical
   axis and L on the horizontal axis

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answers
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The MPL and the production function
Y output
MPL
L labor
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Consumption (C)

• durable goods last a long time ex cars, home
  appliances
• non-durable goodslast a short time ex food,
  clothing
• serviceswork done for consumers ex dry
  cleaning, air travel.

def the value of all goods and services bought
by households. Includes
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U.S. Consumption, 2001
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Investment (I)

• def1 spending on the factor of production
  capital.
• def2 spending on goods bought for future use.
• Includes
• business fixed investmentspending on plant and
  equipment that firms will use to produce other
  goods services
• residential fixed investmentspending on housing
  units by consumers and landlords
• inventory investmentthe change in the value of
  all firms inventories

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U.S. Investment, 2001
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Government spending (G)

• G includes all government spending on goods and
  services.
• G excludes transfer payments (e.g. unemployment
  insurance payments), because they do not
  represent spending on goods and services.

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Government spending, 2001
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Net exports (NX EX - IM)

• def the value of total exports (EX) minus the
  value of total imports (IM)

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CASE STUDY The Reagan Deficits

• Reagan policies during early 1980s
• increases in defense spending ?G gt 0
• big tax cuts ?T lt 0
• According to our model, both policies reduce
  national saving

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1. The Reagan deficits, cont.
1. The increase in the deficit reduces saving
2. which causes the real interest rate to rise
3. which reduces the level of investment.
I2
I1
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Are the data consistent with these results?

• variable 1970s 1980s
• T G 2.2 3.9
• S 19.6 17.4
• r 1.1 6.3
• I 19.9 19.4

TG, S, and I are expressed as a percent of
GDP All figures are averages over the decade
shown.
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U.S. Unemployment, 1958-2002
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Natural Rate of Unemployment

• Natural rate of unemployment the average rate
  of unemployment around which the economy
  fluctuates.
• In a recession, the actual unemployment rate
  rises above the natural rate.
• In a boom, the actual unemployment rate falls
  below the natural rate.

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Example

• Each month, 1 of employed workers lose their
  jobs (s 0.01)
• Each month, 19 of unemployed workers find jobs
  (f 0.19)
• Find the natural rate of unemployment

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Why is there unemployment?

• If job finding were instantaneous (f 1), then
  all spells of unemployment would be brief, and
  the natural rate would be near zero.
• There are two reasons why f lt 1
• 1. job search
• 2. wage rigidity

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Job Search Frictional Unemployment

• frictional unemployment caused by the time it
  takes workers to search for a job
• occurs even when wages are flexible and there are
  enough jobs to go around
• occurs because
• workers have different abilities, preferences
• jobs have different skill requirements
• geographic mobility of workers not instantaneous
• flow of information about vacancies and job
  candidates is imperfect

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Sectoral shifts

• def changes in the composition of demand among
  industries or regions
• example Technological change increases demand
  for computer repair persons, decreases demand for
  typewriter repair persons
• example A new international trade agreement
  causes greater demand for workers in the export
  sectors and less demand for workers in
  import-competing sectors.
• It takes time for workers to change sectors, so
  sectoral shifts cause frictional unemployment.

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Industry shares in U.S. GDP, 1960
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Industry shares in U.S. GDP, 1997
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Sectoral shifts abound

• more examples
• Late 1800s decline of agriculture, increase in
  manufacturing
• Late 1900s relative decline of manufacturing,
  increase in service sector
• 1970s energy crisis caused a shift in demand away
  from huge gas guzzlers toward smaller cars.
• In our dynamic economy, smaller (though still
  significant) sectoral shifts occur frequently,
  contributing to frictional unemployment.

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Unemployment from real wage rigidity
If the real wage is stuck above the eqm level,
then there arent enough jobs to go around.
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The minimum wage in the real world

• In Sept 1996, the minimum wage was raised from
  4.25 to 4.75. Heres what happened

Unemployment rates, before after Unemployment rates, before after Unemployment rates, before after
3rd Q 1996 1st Q 1997
Teenagers 16.6 17.0
Single mothers 8.5 9.1
All workers 5.3 5.3

• Other studies A 10 increase in the minimum
  wage increases teenage unemployment by 1-3.

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Labor unions

• Unions exercise monopoly power to secure higher
  wages for their members.
• When the union wage exceeds the eqm wage,
  unemployment results.
• Employed union workers are insiders whose
  interest is to keep wages high.
• Unemployed non-union workers are outsiders and
  would prefer wages to be lower (so that labor
  demand would be high enough for them to get
  jobs).

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Union membership and wage ratios by industry, 2001
RBU nonunion workers represented by a
union wage ratio 100?(union RBU
wage)/(nonunion wage)
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