The Data of Macroeconomics
1. Measuring a Nation's Income
1.1 The Measurement of GDP
GDP measures two things at once:
- the total income of everyone in the economy
- the total expenditure on the economy’s output of goods and services
GDP can perform the trick of measuring both total income and total expenditure because for an economy as a whole, income must equal expenditure.
A definition of GDP that focuses on GDP as a measure of total expenditure:
Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time.
Key points:
- Market Value:
- GDP uses market prices as the measure for all things
- Housing is included:
- rental housing
- owner-occupied housing: estimating its rental value
- Public services are included: civil servant (no market, use the cost value to estimate)
- Excludes products that don't enter a (legal) market
- illegal drugs
- products produced and consumed at home: vegetables you grow in your garden
- "marriage may reduce GDP"
- rent of durable goods (like cars, jewelry, except for housing)
- Final goods: the value of intermediate goods is already included in the prices of the final goods.
- Produced: GDP includes goods and services currently produced (that will enter the market; inventory are included). It does not include transactions involving items produced in the past.
- Within the geographic confines of a country: regardless of the nationality of the producer
- Seasonal Adjustment: government statisticians adjust the quarterly data to take out the seasonal cycle.
1.2 The Components of GDP
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Consumption: spending by households on goods and services, with the exception of purchases of new housing
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Investment: the purchase of goods (called capital goods) that will be used in the future to produce more goods and services
the sum of purchases of business capital, residential capital, and inventories
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Business capital:
business structures (such as a factory or office building)
equipment (such as a worker’s computer)
intellectual property products (such as the software that runs the computer)
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Residential capital:
the landlord’s apartment building and a homeowner’s personal residence
(By convention, the purchase of a new house is the one type of household spending categorized as investment rather than consumption.)
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Inventories:
Concept: One aim of GDP is to measure the value of the economy’s production, and goods added to inventory are part of that period’s production.
- When Apple produces a computer and adds it to its inventory instead of selling it, Apple is assumed to have “purchased” the computer for itself. It is part of Apple’s investment spending.
- If Apple later sells the computer out of inventory, Apple’s inventory investment will then be negative, offsetting the positive expenditure of the buyer.
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Government Purchases: spending on goods and services by local, state, and federal governments
salaries of government workers, expenditures on public works
Transfer payments are not counted as part of government purchases:
The government pays a Social Security benefit to a person who is elderly, which is not made in exchange for a currently produced good or service.
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Net Exports: spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)
Imports are subtracted:
- Someone buys product produced abroad increases consumption.
- But it should not affect GDP.
- So it should be subtracted from exports.
1.3 Real versus Nominal GDP
Nominal GDP: the production of goods and services valued at current prices
Real GDP: the production of goods and services valued at constant (base-year) prices $$ \text{GDP deflator} = { \text{Nominal GDP} \over \text{Real GDP} } \times 100 $$ nominal GDP reflects both:
- the quantities of goods and services the economy is producing
- the prices of those goods and services
real GDP reflects only the quantities produced
The GDP deflator measures the current level of prices relative to the level of prices in the base year.
The inflation rate is the percentage change in some measure of the price level from one period to the next. Using the GDP deflator, $$ \text{Inflation rate in year 2} = { \text{GDP deflator in year 2} - \text{GDP deflator in year 1} \over \text{GDP deflator in year 1} } \times 100 $$
1.4 Meaning of GDP
GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain many of the inputs for a worthwhile life.
GDP is not a perfect measure of well-being.
2. Measuring the Cost of Living
2.1 The Consumer Price Index
2.1.1 Basis
Consumer Price Index (CPI): a measure of the overall cost of the goods and services bought by a typical consumer
5 steps that the Bureau of Labor Statistics follows to calculate CPI:
$$
\text{CPI} = 100 \times { \text{Price of basket in current year} \over \text{Price of basket in base year} }
$$
core CPI: a measure of the overall cost of consumer goods and services excluding food and energy (Because food and energy prices show substantial short-run volatility, the core CPI better reflects ongoing inflation trends.)
Producer Price Index (PPI): a measure of the cost of a basket of goods and services bought by firms
Because firms eventually pass on their costs to consumers in the form of higher consumer prices, changes in the PPI are often thought to be useful in predicting changes in the CPI.
2.1.2 Problems of CPI
Substitution Bias: If a price index is computed assuming a fixed basket of goods, it ignores the possibility of consumer substitution and, therefore, overstates the increase in the cost of living from one year to the next.
Introduction of new goods:
- When a new good is introduced, consumers have more variety from which to choose, and this in turn reduces the cost of maintaining the same level of economic well-being.
- the increased set of possible choices makes each dollar more valuable
Unmeasured quality change: If the quality rises from one year to the next, the value of a dollar rises.
2.1.3 Comparison with GDP Deflator
| GDP Deflator | CPI |
|---|---|
| the prices of all goods and services produced domestically | the prices of all goods and services bought by consumers** |
| compares the price of a fixed basket of goods and services | compares the price of currently produced goods and services |
2.1.4 Indexation
Indexation: the automatic correction by law or contract of a dollar amount for the effects of inflation
The interest rate that measures the change in dollar amounts is called the nominal interest rate, and the interest rate corrected for inflation is called the real interest rate.
Real interest rate = Nominal interest rate - Inflation rate.