The Measurement of Macroeconomic Variables

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CHAPTER 6 The Measurement of Macroeconomic
Variables
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Before we start our study of macroeconomics, we
have to define some commonly used terminology --
i.e., learn the JARGON.
I Introduction
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Questions to be addressed

• How do we measure production output in the
  economy?
• How do we measure prices for the economy as a
  whole?
• What is inflation?
• What do economists mean by unemployment?
• What determines interest rates?

• These notes focus on the measurement of output
  and prices.

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II Measuring a Nations output
Gross Domestic Product ( GDP )
The value of the aggregate production of final
goods and services in a country during a given
time period. We only include output where there
is a market transaction -- household production
not sold is left out.
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Some Basic Definitions

• Capital Stock
• durable plant, equipment, and buildings and
  inventories that are used to produce other goods
  and services.
• Depreciation (capital consumption)
• the decrease in the value of the stock of capital
  that results from wear and tear and obsolescence
  becoming outdated.

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• Gross Investment
• the total amount spent on producing capital goods
  including additions to inventories.
• Net Investment
• net investment equals gross investment minus
  depreciation, so it is the amount by which the
  capital stock increases

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Capital and Investment
Capital stock
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Gross Investment
Net investment during 1997
3
Initial capital
Depreciation
2
1
0
Jan. 1, 1998
During 1998
Dec. 31, 1998
Time
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Approaches to Measuring GDP

• The Expenditure Approach- this approach
  measures by measuring the spending on final
  output Y. One agents spending is anothers
  receipt, so spending on output equals value of
  output.

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Final versus Intermediate

• We only want FINAL output, namely
• CONSUMPTION, i.e. all expenditures by households
  except purchases of new housing
• GROSS INVESTMENT, i.e. all expenditures by firms
  on capital goods and additions to inventories
  plus purchases of new housing
• GOVERNMENT, all spending convention
• NET EXPORTS, i.e. spending on US output by
  foreigners exports less our purchases from them
  imports.

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Intermediates

• INTERMEDIATE goods and services are those things
  wholly used up during the time period to produce
  other things.
• Examples newsprint bought by a newspaper
  company, diesel fuel and oil bought by a trucking
  firm, flour bought by a bakery, bread bought by a
  supermarket or a sandwich shop, sheet steel
  bought by an auto manufacturer, etc.

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WHO, not WHAT

• A paperclip is
• consumption if a student buys it
• investment if an office-supply store buys it to
  add to inventory
• government expenditure if FSU buys it
• exports if it is sold to Canada
• intermediate if Publix buys it for its office.

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• How can output be used?
• Personal consumption expenditure (C)
• Gross domestic investment (Ig)
• Government purchases of Goods and
  Services (G)
• Net exports of goods services (X - M)

YC Ig G X - M
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GDP The Expenditure Approach
Amount in 1999 (billions of Percentage Item
Symbol dollars of GDP

• Personal consumption expenditures C 6,269 67.4
• Gross private domestic investment Ig 1,650 17.
  7
• Government purchase of goods and
  services G 1,634 17.6
• Net exports of good and services X-M 254
  2.7
• Gross domestic product Y 9,299 100.0

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• Expenditures not in GDP

• intermediate goods and services
• used goods
• financial assets
• transfers
• household-production not sold

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• The Income Approach- this approach measures by
  adding up the incomes that are paid to
  resources factor inputs for their
  contribution to production -- if we measure
  right, total input incomes cost of output
  value of output GDP.

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• What are these incomes?
• Compensation of employees(wages, salaries,
  fringes employment cost)
• Net interest
• Rental income
• Corporate profits
• Proprietors income

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• The sum of the five categories are measured at
  factor cost. We want to convert to market
  prices

• Add indirect business taxes
• add depreciation neither is a payment for
  productive services, but they are in GDP
• We also need to correct for any net payments
  to/from foreigners for factor inputs NFIFA, Net
  Factor Income From Abroad

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GDP The Income Approach
Amount in 1999 Percentage Item (billions
of dollars of GDP

• Compensation of employees 5,300 57.0
• Net Interest 507 5.5
• Rental Income 143 1.5
• Corporate Profits 856 9.2
• Proprietors income 663 7.1
• Indirect taxes less subsidies 680 7.3
• Capital consumption (depreciation) 1,161 12.5
• NFIFA -11 -0.1
• Gross domestic 9,299 100.0 product
• Net Factor Income From Abroad

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Aggregate Expenditure,Output, and Income
Percentageof GDP
100
80
60
40
20
0
Aggregate expenditure
Aggregate income
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• How do we avoid double counting, given we dont
  know whether things are final or intermediate
  when they are produced?
• Value added - the value of a firms production
  minus the value of all the intermediate goods the
  firm used.
• Example A miller buys wheat from a farmer for
  1.00 and sells flour to the baker for 1.50.
  The millers value added is 0.50.
• The value of a final good is the selling price to
  the final purchaser.

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Value Added An Example
Purchase Price or IntermediateInput Cost
Value Added
Sales Price
Farmer
1.00
1.00
0.00
Miller
0.50
1.50
1.00
Baker
1.50
1.75
0.25
0.25
Grocer
2.00
1.75
Consumer
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Value Added and Final Expenditure
Value added
Farmer
Intermediate expenditure
Miller
Final expenditure
Baker
Grocer
Consumer
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Value Added and Incomes

• Value added is firms sales minus cost of
  intermediates
• This is equal to incomes of factor inputs used by
  the firm plus depreciation and net indirect taxes
• Expenditure and income approaches both measure
  GDP total incomes plus depreciation and
  indirect taxes equal total value added equal
  cost of producing final output equal expenditure
  on final output.

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Reality Note

• Many governments also estimate GDP by an output
  method too, collecting data directly on output of
  final goods
• The two or three methods should produce the
  same number for GDP. In practice, they dont --
  sometimes even one rises, another falls. So
  there are balancing items or errors and
  omissions lines to make them equal.

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Imputations

• Two estimates of expenditure are included in GDP
  although there are no transactions
• One is the rental value of owner-occupied
  housing
• The other is the value of own-consumption of
  food produced by farm households

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GDP is what it is

• GDP is the best approximation of economic output
  we have
• To get a number, we need some arbitrary rules or
  conventions
• GDP does NOT measure well-being

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III Measuring Aggregate Prices
- In the US economy, many goods, each with its
own price, are available each period. - A price
index summarizes the aggregate level of a defined
set of prices.
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Two main prices indexes

• CPI - The Consumer Price Index
• measures the average level of prices of goods and
  services that an urban family buys on average.
• Published monthly by the Bureau of Labor
  Statistics
• Must use a base period (the point of comparison)
• http//stats.bls.gov/sahome.htmlCPI

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Two main prices indexes

• GDP deflator
• Measures the average level of prices of all the
  goods and services that are included in GDP
• Also must use a base year (the point of
  comparison)
• Is based on the chain index used to calculate
  real GDP -- i.e., no fixed basket of goods and
  services.

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Price Index The CPI example

• In order to calculate the CPI, the Bureau of
  Labor Statistics takes the prices of a market
  basket of goods urban families bought on average
  in the base time period.
• By looking at the ratio of the price of this
  basket across time periods, we can see how
  prices in one year compare to another.
• In order to make the comparison an index, we use
  a common base year price index set equal to
  100 to compare each other year to.

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The CPI basket of goods and services

• The basket of goods and services used in the CPI
  is the average basket based on an expenditure
  survey.
• It is not what any family actually bought,
  because it is an average e.g., it includes both
  an element of costs of owning a house and
  elements of renting housing -- because on
  average, families do both. Real families dont
  do both at once, however.

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Base Period Current
period Base-period basket Price Expenditure
Price Expenditure

• 5 pounds of oranges 0.80/pound 4
• 6 haircuts 11.00 each
  66
• 100 bus rides 1.40 each
  140 Total expenditure
  210

1.20/pound 6 12.50 each
75 1.50 150
231
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• By observing the movement of prices through time
  using either the CPI or the GDP deflator we can
  make generalizations regarding the recent path of
  price levels.

• Inflation- the growth of price levels through
  time. Inflation rate is the growth rate of the
  price level
• Deflation- the reduction of price levels
  through time.

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Application of Price IndexThe relative value of
a wage.
http//www.homefair.com/calc/salcalc.html?NETSCAPE
_LIVEWIRE.srcmoneymag
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The relative value of a wage (cont.)

• Suppose you are currently earning 30,000 in
  Tallahassee.
• Two firms offer you a job.
• A firm in Manhattan, NY offers you 60,000.
• A firm in San Francisco offers you 50,000.
• If purchasing power is your overriding objective,
  which job should you take?

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The relative value of a wage (cont.)
Suppose price indices for renters
are Tallahassee 100 Manhattan, NY 220.8 San
Francisco 168.0. Then,
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GDP measured in current prices is nominal or
money GDP

• Nominal GDP in the United States was13 times
  greater in 1994 than in 1960. Was output higher
  in 1994 than in 1960?
• Nominal GDP can increase due to a price increase
  or a quantity increase.
• We need to adjust nominal GDP for inflation. The
  adjusted GDP is called real GDP.

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Calculation of a Real Variable

• Real GDP is a measure of a countrys total output
  of goods and services after adjusting for
  inflation.

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Real GDP in the US

• Nowadays, in the US real GDP is estimated using
  a chain index method
• This means, each year is linked to the next by
  calculating values of each year using those two
  years average prices and actual quantities
• This means more gradual adjustment to the fact
  that the relative quantities of different goods
  can change quite fast in GDP e.g. computers.

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Real GDP in the US continued

• The GDP deflator is then derived from comparison
  of the real GDP numbers produced by the
  chain-index method and the nominal GDP numbers
• The GDP deflator is therefore NOT obtained from a
  fixed basket -- the basket changes each year,
  because the composition of GDP changes each year.
  

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Real and money variables

• Real is unreal -- something you cannot
  measure directly jargon
• In general,
  money equals
  real times price index divided by 100 if
  index has 100 as base

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Example Importance of comparing variables in
real terms over time.
Brazil(cruzeiros)
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Calculation of a Growth Rate

• The annual growth rate, or rate of growth, of any
  economic variable is the percentage change from
  one year to the next.

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Growth Rate

• Growth Rate GDP

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Example

• Growth Rate of Brazilian money GDP

618,600 - 57,100

X 100
983.36
57,100
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Growth of Real GDP in Brazil

• Growth rate is 10,930 - 11,029/(11,029) times
  100 , i.e. - 0.9
• Minus 0.9 -- real GDP fell
• The difference was inflation -- the price level
  went up faster than money GDP increased

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Economic Growth in theUnited States
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Economic growth (the trend line)

• Economic growth is the expansion of the economys
  production possibilities.

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Business cycles - (short run macroeconomics)

• The difference between potential GDP (trend line)
  and actual GDP is the business cycle. Main
  phases of the Business Cycle
• Recession Period during which real GDP decreases
  for at least two successive quarters
• Expansion Period during which real GDP
  increases. The Turning Points are
• Peak Expansion ends, recession begins
• Trough Recession ends, expansion begins

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A recent U.S. Business Cycle
RealGDP(in Tillions)
7.0
Potential GDP(Long-run Trend)
6.5
6.0
5.5
1987
1991
1986
1988
1989
1990
1992
1993
1994
1995
1996
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Real GDP is not a perfect measure

• Over adjustment for inflation
• household production not included
• underground/illegal economic activity poorly
  measured
• health and life expectancy ignored
• leisure time ignored
• environmental quality ignored
• political freedom and social justice ignored