CHAPTER TWO
The Data of Macroeconomics
Mannig J. Simidian
Chapter Two 1
Gross Domestic Product (GDP) is the
market value of all final goods and services
produced within an economy in a given
period of time.
Chapter Two 2
Income, Expenditure
And the Circular Flow
There are 2 ways Total income of everyone in the economy
of viewing GDP Total expenditure on the economys
output of goods and services
Income $
Labor
Households Firms
Goods
Expenditure $
For the economy as a whole, income must equal expenditure.
GDP measures the flow of dollars in this economy. 3
Chapter Two
1) To compute the total value of different goods and services, the
national income accounts use market prices.
Thus, if
$0.50 $1.00
5) Some goods are not sold in the marketplace and therefore dont
have market prices. We must use their imputed value as an estimate
of their value. For example, home ownership and government services.
Chapter Two 5
The value of final goods and services measured at current prices is called
nominal GDP. It can change over time either because there is a change
in the amount (real value) of goods and services or a change in the prices
of those goods and services.
Hence, nominal GDP Y = P y, where P is the price level and y is real
output and remember we use output and GDP interchangeably.
Real GDP or, y = YP is the value of goods and services measured using
a constant set of prices.
This distinction between real and nominal can also be applied to other
monetary values, like wages. Nominal (or money) wages can be denoted
by W and decomposed into a real value (w) and a price variable (P).
Hence, W = nominal wage = P w
w = real wage = w/P
This conversion from nominal to real units allows us to eliminate the
problems created by having a measuring stick (dollar value) that
essentially changes length over time, as the price level changes. 6
Chapter Two
Lets see how real GDP is computed in our apple and
orange economy.
The GDP deflator, also called the implicit price deflator for GDP,
measures the price of output relative to its price in the base year. It
reflects whats happening to the overall level of prices in the economy.
Chapter Two 8
In some cases, it is misleading to use base year prices that
prevailed 10 or 20 years ago (i.e. computers and
college). In 1995, the Bureau of Economic Analysis
decided to use chain-weighted measures of
real GDP. The base year changes continuously
over time. This new chain-weighted
Average prices in 2001 measure is better than the more
and 2002 are used to measure traditional measure because it
real growth from 2001 to 2002. ensures that prices will not be
Average prices in 2002 and 2003 too out of date.
are used to measure real growth from
2002 to 2003 and so on. These growth
rates are united to form a chain that is
used to compare output between any two
dates.Chapter Two 9
Y
Y == CC ++ II ++ G
G ++ NX
NX
Totaldemand
Total demand Investment
Investment
fordomestic
for domestic isiscomposed
composed spendingby
spending by
output(GDP)
output (GDP) of
of businessesand
businesses and
households
households Netexports
Net exports
ornet
or netforeign
foreign
Consumption Government demand
demand
Consumption Government
spendingby
spending by purchasesof
purchases ofgoods
goods
households
households andservices
and services
Chapter Two 12
Lets see how the CPI would be computed in our
apple and orange economy.
For example, suppose that the typical consumer buys 5 apples and 2
oranges every month. Then the basket of goods consists of 5 apples
and 2 oranges, and the CPI is:
In this CPI calculation, 2002 is the base year. The index tells how
much it costs to buy 5 apples and 2 oranges in the current year
relative to how much it cost to buy the same basket of fruit in 2002.
Chapter Two 13
The GDP deflator measures the prices of all goods produced, whereas
the CPI measures prices of only the goods and services bought by
consumers. Thus, an increase in the price of goods bought by firms or
the government will show up in the GDP deflator but not in the CPI.
Also, another difference is that the GDP deflator includes only those
goods and services produced domestically. Imported goods are not a
part of GDP and therefore dont show up in the GDP deflator.
The final difference is the way the two aggregate the prices in the
economy. The CPI assigns fixed weights to the prices of different
goods, whereas the GDP deflator assigns changing weights.
Chapter Two 14
The labor force is defined as the sum of the employed and
unemployed, and the unemployment rate is defined as the
percentage of the labor force that is unemployed.
The labor force participation rate is the percentage of the adult
population who are in the labor force.
Chapter Two 15
The negative relationship between unemployment and GDP is called
Okuns Law, after Arthur Okun, the economist who first studied it.
Chapter Two 17