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Introduction to Macroeconomics
Chapter 4
Measuring Output of the Macroeconomy
Introduction to Macroeconomics
Chapter 4. Measuring the Macroeconomy
1. Measuring Total Output2. How to Measure GDP3. GDP Accounting Complications4. Nominal and Real GDP5. Measuring Price Changes6. Empirical Applications
Introduction to Macroeconomics
1. Measuring Total Output
• Monetary Measure of Value
• GDP versus GNP
• Omissions from GDP - does not measure social welfare
Introduction to Macroeconomics
1. Measuring Total Output Monetary Measure of Value
Quantity times Price equals Market Value
Cars 1,000 x $20,000 = $20,000,000
Dolls 10,000 x $ 10 = $ 100,000
Total Value of Output = $20,100,000
Introduction to Macroeconomics
1. Measuring Total Output GDP versus GNP
• Nominal Gross Domestic Product (GDP) - the market value of final goods and services (i.e., sold to final consumers) produced by a nation during a specific period, usually 1 year.
• Nominal Gross National Product (GNP) - the market value of final goods and services produced by labor and property supplied by the residents of a nation during a specific period, usually 1 year.
Introduction to Macroeconomics
1. Measuring Total Output Omissions from GDP
GDP is a poor measure of social welfare:• Leisure• Home and volunteer labor
(non market production)• Depletion of nonrenewable resources• Unregulated pollution• Distribution of income• Differences in preferences
Introduction to Macroeconomics
2. How to Measure GDP
• Circular Flow
• Expenditure Approach
• Income Approach
Introduction to Macroeconomics
2. How to Measure GDP Circular Flow of Income and Expenditures
Households BusinessFirms
Resources
Income
Goods and Services
Expenditures
Solid Lines - Flow of MoneyDashed lines - Flow of Goods and Services
Introduction to Macroeconomics
2. How to Measure GDP Expenditure Approach
• GDP = Consumption Spending (C)
+ Private Domestic Investment (I)
+ Government Spending (G)
+ Exports - Imports (net exports, NX)
• GDP = C + I + G + NX
Introduction to Macroeconomics
2. How to Measure GDP Expenditure Approach: Expenditure Shares
Consumption69.9 %
Government Spending18.8 %
Investment15.2 %
2002 U.S. Nominal Gross Domestic Product
Net Exports = - 4.1 % (not shown in slide)
Introduction to Macroeconomics
2. How to Measure GDP Expenditure Approach: Consumption
40%
45%
50%
55%
60%
65%
70%
75%
1959 1969 1979 1989 1999
Per
cen
t o
f G
DP
U.S.
Japan
1999U.S. 68.2 %Japan 60.1 %
Introduction to Macroeconomics
2. How to Measure GDP Expenditure Approach: Government
0%
5%
10%
15%
20%
25%
30%
35%
1959 1969 1979 1989 1999
Per
cen
t o
f G
DP
U.S.
Japan
1999U.S. 17.6 %Japan 18.4 %
Introduction to Macroeconomics
2. How to Measure GDP Expenditure Approach: Investment
0%
5%
10%
15%
20%
25%
30%
35%
1959 1969 1979 1989 1999
Per
cen
t o
f G
DP
U.S.
Japan
1999U.S. 17.9 %Japan 20.0 %
Introduction to Macroeconomics
2. How to Measure GDP Expenditure Approach: Net Exports
-6%
-4%
-2%
0%
2%
4%
6%
1959 1969 1979 1989 1999
Per
cen
t o
f G
DP
U.S.
Japan
1999U.S. - 3.7 %Japan 1.5 %
Introduction to Macroeconomics
2. How to Measure GDP Income Approach
• National Income = GDP (with corrections)
• Personal Income = National Income (with corrections)
• Personal Income - Personal income taxes - Social Security withholding = Disposable Personal Income
Introduction to Macroeconomics
3. GDP Accounting Complications
• Double Counting
• Depreciation
Introduction to Macroeconomics
3. GDP Accounting Complications Double Counting
• Intended for “final” use– excludes intermediate products
• Value Added– excludes used goods
Introduction to Macroeconomics
3. GDP Accounting Complications Depreciation
Gross Investment
- Depreciation
= Net Investment
Gross Domestic Product (GDP)
- Depreciation
= Net Domestic Product (NDP)
Introduction to Macroeconomics
4. Nominal and Real GDP
• Definitions
• Sample Problem
• GDP Growth
Introduction to Macroeconomics
4. Nominal and Real GDP Definitions
• Nominal GDP– Value of output measured at actual prices
(current dollar output)– Does not correct for inflation
• Real GDP– Value of output based on prices of some base
period (“constant” dollar output)– eliminates effect of inflation
Introduction to Macroeconomics
4. Real GDP Sample Problem
Average Prices Quantity Sold
1992 1994 % Change 1992 1994
Food $ 12 $ 14 17 % 4 5
Housing 9 10 11 % 3 3
Fun 4 5 25 % 3 4
Machines 20 20 0 % 2 2
Introduction to Macroeconomics
4. Real GDP Definition of Nominal GDP
Nominal GDP
= Current year Quantities
x Current year Prices
Introduction to Macroeconomics
4. Real GDP Sample Problem: 1992 Nominal GDP
= 1992 Quantities x 1992 Prices
= 1992 Spending onFood Housing Fun Machines
= 4 • $12 + 3 • $9 + 3 • $4 + 2 • $20
= $48 + $27 + $12 + $40
= $127
Introduction to Macroeconomics
4. Real GDP Sample Problem: 1994 Nominal GDP
= 1994 Quantities x 1994 Prices
= 1994 Spending onFood Housing Fun Machines
= 5 • $14 + 3 • $10 + 4 • $5 + 2 • $20
= $70 + $30 + $20 + $40
= $160
Introduction to Macroeconomics
4. Real GDP Definition of Real GDP
Real GDP
= Current year Quantities
x Base year Prices
Introduction to Macroeconomics
4. Real GDP Sample Problem: 1992 Real GDP
= 1992 Quantities x 1992 Prices
Food Housing Fun Machines
= 4 • $12 + 3 • $9 + 3 • $4 + 2 • $20
= $48 + $27 + $12 + $40
= $127
Introduction to Macroeconomics
4. Real GDP Sample Problem: 1994 Real GDP
= 1994 Quantities x 1992 Prices
Food Housing Fun Machines
= 5 • $12 + 3 • $9 + 4 • $4 + 2 • $20
= $60 + $27 + $16 + $40
= $143
Introduction to Macroeconomics
4. Real GDP Sample Problem: GDP Growth
• Growth in Nominal GDP= (160 - 127) • 100 = 26%
127
• Growth in Real GDP= (143 - 127) • 100 = 13%
127
Introduction to Macroeconomics
5. Measuring Price Changes
• Price index
• GDP deflator
• Consumer price index
• Problems with price indexes
Introduction to Macroeconomics
5. Measuring Price ChangesPrice indexes
• Price Index: a measure of the change in the average level of prices
• GDP Deflator– Base-year prices– Quantities variable– Imports excluded
• Consumer Price Index– Base year quantities– Prices variable– Imports included
Introduction to Macroeconomics
5. Measuring Price ChangesGDP deflator
GDP Deflator = Nominal GDP • 100
Real GDP
1992 GDP Deflator = 127• 100 = 100.0
127
1994 GDP Deflator = 160 • 100 = 111.9
143
Introduction to Macroeconomics
5. Measuring Price ChangesInflation
Change in Average Level of Prices
= Percent Change in GDP Deflator
Inflation from 1992 to 1994
= (1994 Deflator - 1992 Deflator) • 100
1992 Deflator
= (111.9 - 100.0) • 100 = 11.9%
100.0
Introduction to Macroeconomics
5. Measuring Price ChangesProblems with price indexes
• Substitution bias - changes in relative prices– between goods (butter vs margarine)– between stores (small vs large discounters)
• Quality changes and new products
• Chain-weighted indexes
Introduction to Macroeconomics
6. Empirical Applications
• Use Real rather than Nominal values
• Compare Per Capita rather than Aggregates
• Compare Growth Rates rather than Levels
Introduction to Macroeconomics
6. Empirical Applications Compare Per Capita rather than Aggregates
Real GDP Per Capita, 1929 - 2002
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
1929 1939 1949 1959 1969 1979 1989 1999
Ch
ain
ed
19
96
Do
llars
Source: Bureau of Economic Analysis (www.bea.doc.gov)
Introduction to Macroeconomics
6. Empirical Applications Compare growth rates rather than levels
10-year Changes in Real GDP Per Capita
0.59%
4.59%
2.39%
3.03%
2.19% 2.05%1.78%
0%
1%
2%
3%
4%
5%
1930-1939
1940-1949
1950-1959
1960-1969
1970-1979
1980-1989
1990-1999
An
nu
al A
ve
rag
e P
erc
en
t C
ha
ng
e
Source: Bureau of Economic Analysis (www.bea.doc.gov)