Econ 4002.01 Chapter 2
National Income Accounting: Business Investment
Business investment also has three components: -Business (Non-residential) Fixed Investment -Residential Fixed Investment -Inventory Changes (+/-) Don't confuse the concept of business investment expenditures with financial investment. -The economy's investment does not include purchases that merely reallocate existing assets among different individuals. -Purchases of stock, bonds, or existing real estate assets will not be included as part of investment.
National Income Accounting: The 2013 Changes to Measuring GDP
Case Study: The 2013 changes to measuring GDP. -Before 2013, intellectual property was not included in GDP. -Beginning in 2013, spending on intellectual property is included as part of investment. -To allow comparisons between the years before 2013 and the years after, the data for all prior years were adjusted to reflect the change.
Nominal Vs. Real GDP: Chain-Weighted Real GDP
A chain-weighted real GDP uses a rolling average of prices. -The problem is that base year prices lose their usefulness the further we get from the base year. --Relative prices for many goods and services may have changed substantially. -To reduce the impact of these relative price changes, the real GDP for each year in a chain represents the average of the current and previous years prices. --There is, in effect, a rolling base year.
Consumer Price Index (CPI)
A measure of the overall level of prices that shows the cost of a fixed basket of consumer goods relative to the cost of the same basket in a base year. The most commonly used measure of the level of prices. The CPI turns the prices of many goods and services into a single index measuring the overall level of prices. The Bureau of Labor Statistics computes the CPI. (Think opposite of Real GDP. Instead of holding prices at a fixed amount, you hold quantity at a fixed amount.)
Measuring Joblessness: The Establishment Survey
A second survey, called the establishment survey, gather data about hiring and wages from about 160,000 large employers. -Each month the Bureau of Labor statistics reports on new job creation based on the establishment survey. -Because of the large sample size, many economists believe that the establishment survey yields more accurate information. The employment data from the two surveys are correlated, but do not match. -A person that runs their own business is employed in the household survey, but not counted in the establishment survey. -A person with multiple jobs will be only counted once in the household survey, but multiple times in the establishment survey. -Start-up companies might not be included in the establishment survey. -The estimates based on the household survey may be in error because the estimated population is incorrect.
Stocks and Flows
A stock is a quantity measured at a given point in time, whereas a flow is a quantity measured per unit of time. Think of a faucet and tub. Stock: 1. A variable measured as a quantity at a point in time. 2. Shares of ownership in a corporation. Flow: 1. A variable measured as a quantity per unit of time.
Measuring The Cost of Living: Price Index Correlation
All of the price indexes (CPI, GDP deflator, and PCE deflator) tend to be correlated.
GDP Deflator
Also called the implicit price deflator for GDP. The ratio of nominal GDP to real GDP; a measure of the overall level of prices that shows the cost of the currently produced basket of goods relative to the cost of that basket in a base year.
Imputed Value
Although most goods and services are valued at their market prices when computing GDP, some are not sold in the marketplace and therefore do not have market prices. If GDP is to include the value of these goods and services, we must use an estimate of their value. This estimate is the imputed value. An estimate of the value of a good or service that is not sold in the marketplace and therefore does not have a market price.
Measuring The Cost of Living: PCE Deflator
Another important index is the implicit price deflator for personal consumption or PCE deflator. -The PCE deflator is calculated in the same way as the GDP deflator. -The PCE deflator is based only on the consumer portion of expenditures. -PCE deflator=Nominal Consumption/Real Consumption -The PCE deflator is the Federal Reserve's preferred measure of inflation.
Measuring The Cost of Living: The CPI Adjustment
Does the CPI overstate inflation? -The substitution bias. -The introduction of new goods. -The qualitative bias. A panel of economists studied the CPI and estimated that it over-stated inflation by about 1.1% Adjustments to the measurement of the CPI have reduced the problem to below 1%
3 Key Statistics
Each of the three macroeconomic goals has a set of statistics that can be used to monitor it. -Stable Growth--Gross Domestic Product -Stable Prices--Consumer Price Index -Full Employment--Unemployment Rate
Macroeconomic Data
Economic data provide a systematic and objective source of information about the state of the economy. Economists use this data to study the economy; policymakers use this data to monitor developments and formulate policies.
Net Exports
Exports minus inputs. Accounts for trade with other countries. Net exports are the value of goods and services sold to other countries (exports) minus the value of goods and services that foreigners sell us (imports). Net exports are positive when the value of our exports is greater than the value of our imports and negative when the value of our imports is greater than the value of our exports. Net exports represent the net expenditure from abroad on our goods and services, which provides income for domestic producers.
Measuring Joblessness: Case Study of Men, Women, and Labor Participation
From 1950 to now, the gap between the male and female labor force participation rates have narrowed.
Gross Domestic Product
GDP Often considered the best measure of how well an economy is performing. The total income earned domestically, including the income earned by foreign-owned factors of production; the total expenditure on domestically produced goods and services.
The Value of Economic Activity: GDP
GDP is measured as a market value because we need to put all products in a common measurement. -You cannot add apples and oranges, but you can add the dollar values of each. -Suppose 4 apples have been sold for $0.50 each and 2 oranges have been sold for $1 each. --GDP=($0.50x4)+($1x2)=$4 Notice that GDP only includes currently produced goods. -Previously sold (used) products that change hands will not be included in GDP. -Current activities that improve the value of the used product will be included in GDP. Changes in business inventories are included in GDP. -Products that were produced, but not sold, are considered to have been purchased by the manufacturer. -Production for inventory adds to GDP in the same matter as production for a final sale. Only final goods are used in the measurement of GDP. -There are three categories of goods; crude goods (or raw materials), intermediate goods, and final goods. -The value of the final good reflects the value of the crude goods and intermediate goods that were used to produce it. -By only counting final goods, we avoid the problem of double counting.
Government Purchases
Goods and services bought by the government (federal, state, and local). This category includes such items as military equipment, highways, and the services provided by government workers. It does not include transfer payments to individuals, such as Social Security and welfare. Because transfer payments reallocate existing income and are not made in exchange for goods and services, they are not part of GDP.
Consumption
Goods and services purchased by consumers. Consists of household expenditures on goods and services. Goods are tangible items, and they in turn are divided into durables and nondurables. Durable goods are goods that last a long time, such as cars and TVs. Nondurable goods are goods that last only a short time, such as food and clothing. Services include various intangible items that consumers buy, such as haircuts and doctor visits.
Investment
Goods purchased by individuals and firms to add to their stock of capital. Consists of items bought for future use. Investment is divided into three subcategories: business fixed investment, residential fixed investment, and inventory investment. Business fixed investment, also called nonresidential fixed investment, is the purchase by firms of new structures, equipment, and intellectual property products. (Intellectual property products include software, research and development, and entertainment, literary, and artistic originals.) Residential investment is the purchase of new housing by households and landlords. Inventory investment is the increase in firms' inventories of goods (if inventories are falling, inventory investment is negative).
National Income Accounting: Government Purchases
Government purchases represent spending by all levels of government; federal, state, and local. -Goods -Services -Infrastructure Investment
National Income Accounting: Other Measures of Spending and Income
Gross National Product (GNP)=GDP+Factor Payments from Abroad--Factor Payments to Abroad. -Who versus Where. -GDP and GNP are very close for the US, but some countries have large differences. Net National Product (NNP)=GNP-Depreciation. -Depreciation is also known as consumption of fixed capital. -Investment that is designed to replace existing capital does not add to the economy's productive capacity. National Income (NI)=NNP-Statistical Discrepancy. -Reporting errors and timing discrepancies create a statistical error in measurements of income and production. Another way to find national income is to use the income approach and measure the income generated by the production of goods and services. NI=Compensation of Employees+Net Interest+Rental Income+Proprietor's Income+Corporate Profits+Taxes on Production and Imports Personal income (PI) shows how much income the households receive. PI=NI-Indirect Business Taxes-Corporate Profits-Social Insurance Contributions-Net Interest+Dividends+Government Transfers to Individuals+Personal Interest Income Disposable Personal Income (DPI) is the amount of money the households can spend or save. DPI=PI-Personal Taxes=C+S
The Value of Economic Activity
Gross domestic product (GDP) is the market value of all final goods and services produced in a given period of time (usually a year). -Reported by the Bureau of Economic Analysis -National Income Accounts are reported quarterly GDP represents both the total income from production and the total expenditures on production.
National Income Accounting: Household Consumption
Household consumption is divided into three types: -Durable Goods -Nondurable Goods -Services
Measuring The Cost of Living
Inflation is an increase in the overall level of prices. The inflation rate is the percentage change in the level of prices.
National Income Accounting: Net Exports
Net exports are the value of a country's exports minus the value of its imports. -Net Exports=Exports-Imports -Exports add to GDP -Imports subtract from GDP
Conclusions
Notice that all macroeconomic statistics have potential biases and measurement errors. -No statistic is a perfect measure. -Some of the variation in statistics from period to period is due to the measurement errors. -To reduce some of the problems related to measurement, you should try to look for trends in the data over several reporting periods. Despite problems with the data, these statistics help us to quantify the performance of the economy. -Policymakers can estimate the current situation in the economy. -Macroeconomists can develop and test theories about how the economy behaves.
National Income Accounting: Seasonal Adjustment
One final adjustment, seasonal adjustment, is often made. -Many economic statistics show regular and predictable seasonal patterns. -Macroeconomists are looking for deviations from normal patterns, so a seasonal adjustment removes normal variations from the numbers and reveals any unusual variations. -Data will be marked as either (SA) if it has been seasonally adjusted or (NSA) if it has not been seasonally adjusted.
FYI: Two Arithmetic Tricks
Percentage change in a variable that is a multiple of two other variables. Nominal GDP=PxY %ΔNominal GDP=%ΔP+%ΔY Percentage change in a variable that is a ratio of two other variables. Real GDP=Nominal GDP/GDP deflator %ΔReal GDP=%ΔNominal GDP-%ΔGDP Deflator
Nominal Vs. Real GDP
Real GDP provides a true measure of production or buying power of income. -Nominal GDP is expressed in terms of current prices so that an increase in nominal GDP could be the result of either an increase in production or an increase in price. -Real GDP is calculated using a base or constant price so that increases in real GDP can only be the result of an increase in production. --One year is selected as the base year and the prices for that year are used to calculate the GDP for every year.
Nominal Vs. Real GDP: Example
Suppose the price of an apple in year 1 is $0.50 and $1.00 in year 2. 100 apples are produced in year 1 and 75 apples are produced in year 2. Assume that year 2 is the base year. Calculate the nominal and real GDP for each year. -Nominal GDP in year 1=$0.50x100=$50 -Nominal GDP in year 2=$1.00x75=$75 -Real GDP in year 1=$1.00x100=$100 -Real GDP in year 2=$1.00x75=$75
PCE Deflator
The PCE deflator is the ratio of nominal consumer spending to real consumer spending. It is the implicit price deflator for personal consumption expenditures. It's a measure of inflation. Calculated like the GDP deflator but, rather than being based on all of GDP, it is based on only the consumption component of GDP.
The Value of Economic Activity: Value Added
The concept of value added can be used to illustrate the previous idea about GDP. -Value added is the difference between the value of the resources used to produce a good and what the good is sold for. --Example: A lamp manufacturer uses $20 of materials and labor to produce a lamp and sells it for $30. The manufacturer has added $10 in value by producing the lamp. -Another way to measure GDP is to add up the value added at each stage of production in the economy.
National Income Accounts Identity
The equation showing that GDP is the sum of consumption, investment, government purchases, and net exports. Letting Y stand for GDP, Y=C+I+G+NX. GDP is the sum of consumption, investment, government purchases, and net exports. Each dollar of GDP falls into one of these categories. This equation is an identity—an equation that must hold because of the way the variables are defined. It is called the national income accounts identity.
The Value of Economic Activity: Imputed Value
The imputed value of some goods is also included in GDP. -An imputed value is the estimated value of a product that has not changed hands in a market and, therefore, is not represented in GDP. -Foe example, the value of housing is reflected in GDP for people who rent, but not for people who own their own home. -Imputed values are not estimated for all goods and services that do not have market values because it is too expensive or difficult to determine them. --In home production. --The underground economy.
Measuring The Cost of Living: The Consumer Price Index
The mostly commonly used measure of the level of prices is the consumer price index or CPI. -The CPI is computed each month by the Bureau of Labor Statistics. -The CPI is a single index number that reflects the prices of thousands of products and services. The CPI is a weighted average of the prices of a market basket of goods and services purchased by consumers. CPI = (Current Value of the Market Basket/Base Value of the Market Basket)=(P/Pbase) (Think opposite of Real GDP. Instead of holding prices at a fixed amount, you hold quantity at a fixed amount.)
National Income Accounting
The national income accounts were created during the Great Depression to provide data about the problem and help formulate policy. The national income accounts are divided into four broad categories of spending. -Household Sector--Consumption (C) -Business Sector-Investment (I) -Government (Public) Sector--Government Purchases (G) -Foreign Sector--Net Exports (NX) Total expenditures are the sum of the spending by the four sectors. National Income Accounts Identity: Y=C+I+G+NX
Nominal Vs. Real GDP: GDP Deflator
The nominal and real values for GDP can be used to calculate the GDP deflator (or implicit price deflator for GDP). -The GDP deflator reflects what is happening to the overall price level in the economy. -GDP Deflator=(nominal GDP)/(real GDP)=P/Pbase -In our example: --GDP Deflator year 1=$50/$100=0.5 --GDP Deflator year 2=$75/$75=1.0 Notice that the equation for the GDP deflator can be rewritten to show two other important relationships. -Nominal GDP=Real GDPxGDP deflator -Real GDP=(Nominal GDP)/(GDP deflator)
Labor-Force Participation Rate
The percentage of the adult population in the labor force.
Unemployment Rate
The percentage of those in the labor force who do not have jobs/that are unemployed.
National Income Accounting
The system used to measure GDP and many related statistics. Helps us understand the meaning of GDP more fully. The accounting system that measures GDP and many other related statistics.
Measuring Joblessness
The unemployment rate measures the percent of those wanting to work who do not have a job. -The unemployment rate is calculated each month by the Bureau of Labor Statistics. -The unemployment rate is based on data obtained from a survey of households. The adult population in the country is divided into three groups. -Employed -Unemployed -Out of the Labor Force The labor force is made up of those who are either employed or actively seeking work. -Labor Force=Employed+Unemployed The out of the labor force category is for adults who are not employed and not actively seeking employment. -Retirees -Full-time Students -House Spouses -Discouraged Workers Two measures are considered to be particularly important. -Unemployment Rate=(Unemployed/Labor Force)x100 -Labor Force Participation Rate=(Labor Force/Adult Population)x100
Value Added
The value added of a firm equals the value of the firm's output minus the value of the intermediate goods that the firm purchases. The value of a firm's output minus the value of the intermediate goods the firm purchased.
Nominal GDP
The value of goods and services measured at current prices. Measured in current dollars; not adjusted for inflation. Nominal GDP can increase either because prices rise or because quantities rise.
Real GDP
The value of goods and services measured using a constant set of prices. Measured in constant dollars; adjusted for inflation. Uses prices from the base year and only quantities change in the calculations from one year to another.
Measuring The Cost of Living: Constructing a Price Index
There are three different ways of constructing a price index. -A Laspeyres index uses a fixed market basket. -A Paashe index uses a changing market basket. -A Fisher index uses an average of the other two.
Measuring The Cost of Living: Other Measures of The Price Level
There are two additional commonly reported measures of the price level. -Each month the BLS releases the producer price index (PPI) which measures the prices in a market basket of goods and services purchased by firms. -Each month the BLS reports on the core rate of inflation which measures the increase in the prices of goods and services purchased by consumers excluding food and energy products. Recall that the GDP deflator is also a measure of the level of prices in the economy. There are three key differences in the two measures. -The GDP deflator measures the prices of all goods and services produced in the economy. -The GDP deflator includes only domestically produced goods and services. -The CPI assigns fixed weights to the prices of different goods and services (a fixed market basket), while the GDP deflator assigns changing weights (a changing market basket).
Labor Force
Those in the population who have a job or are looking for a job. The sum of the employed and unemployed.
The Value of Economic Activity: Circular Flow
When you examine the expanded circular flow model, notice that some arrows point toward the main circular flow and some point away from it. -Injections add dollars to the circular flow: Investment, Government Purchases, Exports, Transfer Payments. -Leakages remove dollars from the circular flow: Saving, Taxes, Imports Note the difference between stock values and flow values. (Think faucet and tub.) Picture is of the main circular flow. See slides for expanded version. Chapter 2 Part 1 Slides 8-10