MACROECONOMICS

73-240
Lecture 2

Shu Lin Wee

This version: September 1, 2015

Gauging the Economy

Does Chinas slowdown have any impact on the US economy?

Shanghai Composite index has fallen about 43% since June 2014
(peak)
Chinas economy has been slowing down. How is the US affected?
US GDP 2015 Q2: expanded 3.7%
U.S. corporate profits rose 5.1% (best quarterly gain since 2014Q2)
Investment spending up 3.2% in 2015Q2

Gauging the Economy

Does Chinas slowdown have any impact on the US economy?
China: second largest economy
Major importer of commodities
U.S. Exports to China, however, about 1% of GDP
BUT, in order to prop up its economy, China has devalued its
currency
US factory growth (+) slowed to lowest level since May 2013 (ISM)
Manufacturing exports hit by stronger dollar

Plan for this Lecture

Study GDP
1) Imputation of GDP
2) Three ways of computing GDP
3) What is missing from GDP?

A key quantity: GDP

Why do we care about GDP?

GDP is a measure of market activity

Correlated with other macroeconomic variables such as
consumption, unemployment, etc
Although GDP is still an imperfect measure of
well-being/standard of living (more on this later)
General idea: How much an economy can produce how much
income an economy can earn how much an economy can spend

Who computes GDP today?

The Bureau of economic analysis (BEA) periodically publishes the
National Income and Product Accounts (NIPA). They contain:
1) GDP and its components (more on these later)
2) GDP by state, metropolitan area
3) GDP by industry (I-O tables)
4) International accounts (balance of payments)

You can get all the data here: http://www.bea.gov

BEA uses data from: Census, Bureau of labor statistics (surveys),
Tax returns, Industry estimates...
BEA releases three versions of its estimates:
Advance, Preliminary, Final

3 Definitions of GDP

BEA uses 3 alternative definitions:

Product Approach (value added): Market value of final goods and
services newly produced within a nation during a year.
Expenditure Approach: Total spending on newly produced final
goods and services produced within a nation during a year.
Income Approach (national income): Total Income generated by
newly produced final production, profits and taxes paid by firms
and depreciation within a nation during a year .
We will use the symbol Y to denote either total expenditure,
income or value added!

3 Definitions of GDP (2005 data)

3 Definitions of GDP and 3 Macroeconomic Questions

Product Approach (value added): In the U.S. how much has

manufacturing industry declined and service industry risen?
Expenditure Approach: How much more are Americans spending
on health care now than they did in 1950?
Income Approach (national income): Have workers become poor
at the expense of owners of firms/capital in the U.S. over the last
40 years?

A Key Quantity: GDP

Measurement with Product Approach

GDP by Product Approach

Product Approach: we want to add up the value produced by

every firm/production unit in the economy
But how do we gauge a firms contribution to output?
Supply chain can involve many firms
Look at value added by the firm

GDP by Product Approach

A firms value added is the value of its output minus the value of the
intermediate goods the firm used to produce that output.
GDP = value of final goods produced
= sum of value added at all stages of production
The value of the final goods already includes the value of the
intermediate goods, so including intermediate and final goods in GDP
would be double-counting
Value added of government is equal to the wage of government
employees. Why?

GDP by Product Approach

Using the product approach, we can identify which industries

contributed to GDP growth

We can ask which industries make up the biggest share of GDP

Real GDP in 2015Q1 (Billions of chained 2009 US $)

Industries
GDP
Agriculture, forestry, fishing
Mining
Utilities
Construction
Manufacturing
Wholesale trade
Retail trade
Transportation and warehousing
Information
Finance, insurance, real estate
Services
Government
Source: BEA

Value Added
16287.7
146.2
382.1
275.6
589.3
1942.5
941.8
954.3
426.2
832.6
3226.5
4313.9
2033.7

% of GDP
100
0.90
2.3
1.7
3.6
11.9
5.8
5.9
2.6
5.1
19.8
26.5
12.5

Industry Shares 19472012

Percent of GDP
10
15
20

25

30

Value Added by Manufacturing and Service Industries

as Share of GDP in the U.S.

1947

1957

1967

1977

1987

1997

2007

2017

year
Manufacturing

Services

Source: BEA, GDP by Industry Release

Dramatic rise in services and decline in manufacturing as share of

GDP

Calculate GDP via Product Approach

Firm 1 makes tyres. It sells the tyres to Firm 2 for $100. It hires
workers for $80.
Firm 2 buys the tyres. It hires workers for $100. Firm 2 produces
cars and sells cars to domestic households for $300
.
What is the GDP for this economy via the Product Approach?

A Key Quantity: GDP

Measurement with Expenditure Approach

GDP by Expenditure Approach

Output that is produced is used by one of the following
Consumption expenditures (C): consumer goods and services
Investment (I): investment spending on new capital goods and
change in inventories
Government expenditures (G): government spending on goods
and services
Net exports (NX): goods and services exported minus goods
and services imported
Therefore, GDP (expenditure approach) is comprised by:
GDP = C + I + G + N X

Consumption

Definition: The value of all newly produced goods and services

bought by households.
Includes
Durable Goods: last a long time (cars, home appliances)
Nondurable Goods: last a short time (food, clothing)
Services: work done for consumers (dry cleaning, air travel)

also includes items like: Health expenditure, education, etc.

U.S. consumption, 2013

Consumption
Durables
Nondurables
Services

$ billions
11484.3
1249.3
2601.9
7633.2

Source: Economic Report of the President

http://www.bea.gov/national/nipaweb/Index.asp

% of GDP
68.5
7.5
15.5
45.5

U.S. Real Consumption Growth vs. GDP Growth

Real Gross Domestic Product
Real Personal Consumption Expenditures
10.0

(Percent Change from Year Ago)

7.5

5.0

2.5

0.0

-2.5

-5.0
1960

1970

1980

1990

2000

Shaded areas indicate US recessions - 2014 research.stlouisfed.org

2010

U.S. Real Consumption Growth: Individual

Components
Real Personal Consumption Expenditures: Nondurable Goods
Real Personal Consumption Expenditures: Services
Real Personal Consumption Expenditures: Durable Goods

(Percent Change from Year Ago)

15

10

-5

-10

-15
2000

2002

2004

2006

2008

2010

Shaded areas indicate US recessions - 2014 research.stlouisfed.org

2012

2014

Investment Expenditures
Two definitions:
1

Spending on capital [the factor of production]

Spending on goods bought for future use

Includes
Business fixed investment: Spending on plant and equipment that
firms will use to produce other goods & services.
Residential investment: Spending on housing units by consumers
and landlords.
Inventory investment: The change in the value of all firms
inventories.

U.S. Real Investment Growth vs. GDP Growth

Real Gross Domestic Product
Real Gross Private Domestic Investment, 3 decimal
40

(Percent Change from Year Ago)

30

20

10

-10

-20

-30
1960

1970

1980

1990

2000

Shaded areas indicate US recessions - 2014 research.stlouisfed.org

2010

Government Expenditure

Government Consumption of Goods and Services (about 85% of G)

non-market output such as education, healthcare, policing, defense,
judicial, etc.
goods and services produced by government

Government Invest (about 15%)

e.g. acquiring buildings/machines

excludes transfer payments (e.g., unemployment insurance

payments), because they do not represent spending on goods and
services.

U.S. Government Expenditure, 2006

Government Expenditure
Federal
Non-defense
Defense
State and local

$ billions
2527.7
926.6
305.6
621.0
1601.1

Source: Economic Report of the President

http://www.bea.gov/national/nipaweb/Index.asp

% of GDP
19.1
7.0
2.3
4.7
12.1

Net Export
Net export is the difference between what an economy exports and
imports
N X = exports - imports
If positive, it captures the net expenditure by the rest of the world
on our products
If negative, it captures our net expenditure on what the rest of the
world produces

Net exports (trade balance) for the United States is negative.

The recent trade deficit indicates that the United States is
borrowing goods from the rest of the world.
As the trade balance has turned negative, consumption has
increased as a share of GDP recently.

Expenditure Shares 19292009

Percentage of GDP
20
40
60

80

Expenditure Shares in the U.S. since 1929

1930

1940

1950

1960

1970

Consumption
Government Purchases
Source: BEA, GDP Release, Table 1.1.5

1980

1990

2000

Investment
Net Exports

2010

GDP vs. GNP

Gross National Product (GNP): Total income earned by the

nationss factor of production, regardless of where located
Gross Domestic Product (GNP): Total income earned by the
domestically located factor of production, regardless of nationality
GNP-GDP = factor payments from abroad
factor payments to abroad = N F P

Calculate GDP via Expenditure Approach

Firm 1 makes tyres. It sells the tyres to Firm 2 for $100. It hires
workers for $80.
Firm 2 buys the tyres. It hires workers for $100. Firm 2 produces
cars and sells cars to domestic households for $300
.
What is the GDP for this economy via the Expenditure Approach?

A Key Quantity: GDP

Measurement with Income Approach

Measuring GDP by income approach

Producing goods and services generates income

Wages and Salaries to workers
Profit to owners of business

Total income of all Americans is called National Income

National Income is related to GNP
National Income + depreciation + Sales Taxes = GNP

National Income
National Income is the sum of
Compensation of Employees: wages, salaries and fringe
benefits earned by workers (incl. self-employed income)
Proprietors Income: income of non-corporate business, such as
small farms and law partnerships
Rental Income: income that landlords receive from renting,
including the imputed rent that homeowners pay themselves
Corporate Profits: income of corporations after payments to
their workers and creditors
Net interest: interest paid by domestic businesses plus interest
earned from foreigners

National Income in year 1999

in year 1999

Billions of US
$

% of National
Income

National Income

7469.7

100%

Compensation of Employees

5299.8

71.00%

Proprietors' Income

663.5

8.90%

Rental Income

143.4

1.90%

856

11.50%

507.1

6.80%

Corporate profits
Net interest

Source: Economic Report of the President

http://www.gpoaccess.gov/eop/download.html

0.68
0.66
0.64
0.62
0.6
0.58
0.56
0.54
0.52

Recent years: some decline

2014-01-01

2009-01-01

2004-01-01

1999-01-01

1994-01-01

1989-01-01

1984-01-01

1979-01-01

1974-01-01

1969-01-01

1964-01-01

1959-01-01

1954-01-01

1949-01-01

1944-01-01

1939-01-01

1934-01-01

1929-01-01

Income Shares 19292014

% labor income

Labor income has been a relatively constant fraction of National

Income

Calculate GDP via Income Approach

Firm 1 makes tyres. It sells the tyres to Firm 2 for $100. It hires
workers for $80.
Firm 2 buys the tyres. It hires workers for $100. Firm 2 produces
cars and sells cars to domestic households for $300
.
What is the GDP for this economy via the Income Approach?

can be arrived at by three separate means: as the sum of goods and services sold to final
users, as the sum of income payments and other costs incurred in the production of goods
and services, and as the sum of the value added at each stage of production (chart 2.1).
Although these three ways of measuring GDP are conceptually the same, their calculation
may not result in identical estimates of GDP because of differences in data sources,
timing, and estimation techniques.

In summary

In theory the three definition give the same values...

Chart 2.1Three Ways to Measure GDP

Gross output
Less: Intermediate purchases

Personal consumption
expenditures

Compensation of employees

Equals: Gross value added

Gross private domestic fixed

investment

Taxes on production and

imports less subsidies

Change in private inventories

Net operating surplus

Government consumption
expenditures and gross investment

Consumption of fixed capital

Net exports

GDP
The sum of final
expenditures

GDI
The sum of income payments
and costs incurred in
production

Gross Value Added

The sum of gross value
addedgross output less
intermediate purchases
across all private industries
and government

1. As the sum of goods and services sold to final users. This measure, known as the

It is very important to remember that ..

Only goods and services that are transacted through markets are
included in GDP.
GDP does not include: Government transfer payments to
individuals. (Social Security, Medicare, unemployment insurance.)

From Income and Expenditures to Savings

Taxonomy of Economic Variables

Most of the variables we will study are either:

1

A stock variable: (wealth, capital) quantity accumulated over time

A flow variable: (saving, investment) defining the change of the

relative stock variable

A price
Single price
Price Aggregate (CPI, GDP deflator)

Saving, Wealth and Capital

Stock of capital in an economy determines aggregate productive

capacity
Savings is the addition to the economys wealth
These variables are related. We will explore their relationship next
using measurements of GDP by Expenditures and by Income

Personal Saving

Private saving is the part of personal disposable income that is not

used for current consumption.
But what is personal disposable income?
This is the income people have at their disposal to do whatever
they want with it

(Easiest) Flow of Assets

(Gross) National Savings is the part of GDP that is not consumed
by households or the Government:
S = Y C G
By definition of GDP,
S = I + NX
Divide savings between private and public (or government):
(Y C T ) + (T G) = I + N X
Question: Is Y really the Income that households have
to spend?

Flow of Assets
We know GDP is NOT equal to Households Income
Add Net Factor Payments (N F P ), Govt Transfers (T R), Interest
Income on Govt Debt (IN T )
SP

= Y
| + N F P + T{zR + IN T T} C
Private Disposable Income

{z

Private Sector Saving

S G = |T T R {zIN T G}
Government Saving

Now, we can relate savings, investment and the current account

P
S
+ S G}
| {z

= I + CA

National Saving

where CA = N X + N F P Current Account Surplus

National Savings, Investment and Current Account

-10

-5

Percent of GDP
0
5
10

15

National Savings, Investment and the Current Account

in the U.S. since 1929

1930

1940

1950

1960

Net National Saving

Current Account
Source: BEA, GDP Release, Table 5.1

1970

1980

1990

2000

2010

Net Domestic Investment

The Limits of GDP

Problems with GDP

What is GDP not counting in measuring the size of the economy?
1) Non-market production:
Home production (think about housework, childcare, DIY)
In developing countries: subsistence farmers
(living with 1$ a day means that most of the crops
are for own consumption, few sold for cash)

2) Returns to intangible capital (Brand names, ideas)

3) Underground economy
What does GDP mean?
1) What about environmental costs?
2) What about welfare?

Interpreting GDP: Bads and Regrettables

A bad is a good that the more you have of it, the less happy you
are about it.
GDP measures goods, by definition bads are not included. In
comparing the state of two economies across time and space we
should also consider:
Pollution
Depletion of natural resources

Interpreting GDP: Hours

Is GDP measuring welfare ?
Leisure, health care, education, inequality...

Source OECD.

Interpreting GDP: Inequality

How about inequality?
GDP is a sum, contains no information on distribution
of consumption/income
Interdecile (P90/P10) ratio across countries
Country
Denmark
France
UK
Italy
US
Mexico

P90/P10
2.72
3.39
4.21
4.31
5.91
8.53

Source OECD: http://dx.doi.org/10.1787/826773162617

Interpreting GDP: Inequality over time in U.S.

Source: Guvenen, Ozkan, and Song (NBER WP 18035, 2012)

Roadmap

Today Studied GDP and its components

Next week... Study nominal vs real quantities, prices
After that... A First Macroeconomic Model