Lecture2 - Measurement

Economics 100B: Macroeconomics
Measurement
June 24, 2014
Reading:
Mishkin - Chapter 2
Lecture 2 Measurement: R. J. Hawkins Econ 100B: Macroeconomics 1/ 46
Macroeconomic Measurement
We focus on the major items of macroeconomic interest:
1
Economic Activity.
2
Ination.
3
Unemployment.
4
Interest Rates.
Measuring Economic Activity: National Income Accounting
National Income Accounting
The national income and product accounts are an accounting
framework used to measure economic activity and its components.
The Three Approaches to National Income Accounting
1
Product approach: the dollar amount of output produced.
2
Expenditure approach: the dollar amount spent by
purchasers.
3
Income approach: the dollar incomes earned by production.
Measuring Economic Activity: National Income Accounting
The Three Approaches to National Income Accounting
1
Product approach: the dollar amount of output produced.
2
Expenditure approach: the dollar amount spent by
purchasers.
3
Income approach: the dollar incomes earned by production.
The Fundamental Identity of National Income Accounting
Total Production Total Expenditure Total Income
Measuring Economic Activity: GDP
Approach: Production, Expenditure, Income.
Gross Domestic Product (GDP) is
1
The current market value
2
of all nal goods and services
3
newly produced
4
in the domestic economy
5
during a specied period of time.
Lets explore each of these further.
(1) Market Value
Allows adding together unlike items by valuing them at their
market prices. However, . . .
Imputed values must be used for some nonmarket goods and
services.
Most nonmarket goods and services are not included.
Some market goods and services are not included.
(2) Final Goods and Services
Are those goods and services that are not completely used up in
the production process.
Intermediate goods and services are those completely used up
in the production of other goods and services in the same
period that they themselves were produced.
Adding up value added works because it automatically
excludes intermediate goods.
(2) Final Goods and Services: Two Caveats
1
Capital goods are used to produce other goods and are
treated as nal goods because they are not completely used
up in the same period that they are produced.
2
Inventory investment the amount that inventories of unsold
nished goods, goods in process, and raw materials have
changed during the period is also treated as a nal good.
(3) Newly produced
Counts only things produced in the specied period of time.
(4) In the domestic economy
Counts only goods and services produced within the geographical
boundaries of the country.
(5) Specied period of time
Because GDP is a ow concept, it must be measured during a
specied period of time.
Flows represent an amount per unit of time.
Stocks represent an amount at a particular point in time.
We turn now to the Expenditure approach.
Gross Domestic Product (GDP) is also
1
The total spending
2
on all nal goods and services
3
produced in the domestic economy
4
during a specied period of time.
The four main categories of spending are
1
Consumption (C).
2
Investment (I).
3
Government purchases of goods and services (G).
4
Net Exports (NX).
The national income identity is
Y = C + I + G + NX
This is also known as the income-expenditure identity.
Lets explore the components in more detail.
(1) Consumption.
Is the spending by domestic households on nal goods and services
and has three components:
1
Consumer durable goods.
2
Consumer nondurable goods.
3
Services.
(1) Consumption: Personal Consumption Expenditure
Y = C + I + G + NX
45
50
55
60
65
70
75
40 50 60 70 80 90 00 10 20
P
C
E

(
%

o
f

G
D
P
)
TIME (year)
Source: FRED / BEA
(2) Investment.
Is the spending for new capital goods (xed investment) plus
inventory investment:
1
Business (or nonresidential) xed investment.
2
Residential xed investment.
3
Inventory investment.
(2) Investment: Gross Private Domestic Investment
Y = C + I + G + NX
0
5
10
15
20
25
40 50 60 70 80 90 00 10 20
P
D
I

(
%

o
f

G
D
P
)
TIME (year)
Source: FRED / BEA
(3) Government purchases of goods and services.
Is the spending by the government on goods or services:
1
Federal government purchases.
2
State and local government purchases.
3
Consumption expenditures versus investment.
(3) Government: Current Government Expenditure
Y = C + I + G + NX
10
15
20
25
30
35
40
40 50 60 70 80 90 00 10 20
C
G
E

(
%

o
f

G
D
P
)
TIME (year)
Source: FRED / BEA
(3) Government spending includes
1
Government purchases of goods and services.
the G in Y = C + I + G + NX.
2
Government transfer payments:
include social security, Medicare, Medicaid, Veterans benets
and unemployment insurance.
are payments for which no goods, services, or uses of factors of
production are exchanged in the specied time period.
are not included in G.
Transfer Payments: Current Personal Transfer Receipts
Not Included in GDP
0
5
10
15
20
40 50 60 70 80 90 00 10 20
C
P
T
R

(
%

o
f

G
D
P
)
TIME (year)
Source: FRED / BEA
(4) Net Exports: Exports Imports
Exports are goods produced in the country that are purchased
by foreigners.
Imports are goods produced abroad that are purchased by
residents in the country.
(4) Net Exports: Exports Imports
Y = C + I + G + NX
0
5
10
15
20

Exports
Imports
-10
-5
0
5
10
40 50 60 70 80 90 00 10 20
TIME (year)
Source: FRED / BEA
N
X
,

E
x
p
o
r
t
s

&

I
m
p
o
r
t
s

(
%

o
f

G
D
P
)
NX
We now turn to the Income approach.
Gross Domestic Product (GDP) is also ...
... the total income earned by individuals and businesses in the
economy.
There are ve main income categories:
1
Compensation of employees.
2
Other income.
3
Corporate prots.
4
Depreciation.
5
Net factor income.
There are ve dierent income measures:
1
National Income.
2
Gross Domestic Product (GDP).
3
Gross National Product (GNP).
4
Private Disposable Income.
5
Net Government Income.
Lets look at each in greater detail.
(1) National Income
National Income = Compensation of Employees
+ Other Income
+ Corporate Prots
(2) Gross National Product (GNP)
GNP = National Income + Depreciation
(3) Gross Domestic Product (GDP)
GDP = National Income + Depreciation

GNP
+ Net Factor Payments
or
GDP = GNP Net Factor Income
(4) Private Disposable Income (PDI)
PDI = GDP
+ Net factor income
+ Transfer payments from the government
+ Interest payments on government debt
Taxes
(5) Net Government Income (NGI)
NGI = Taxes
Government transfer payments
Interest payments on government debt
Measuring Economic Activity: Real and Nominal GDP
Nominal and Real Variables
Nominal variables are measured in current dollar terms.
Real variables are adjusted for changes in prices to reect only
quantity terms.
Measuring Economic Activity: Real and Nominal GDP
Nominal and Real GDP
Nominal GDP is the dollar value of an economys nal output
measured at current market prices.
Nominal GDP = Price Level Real GDP
Real GDP is an estimate of the value of an economys nal
output, adjusted for changes in the overall price level.
Real GDP =
Nominal GDP
Price Level
Measuring Economic Activity: Ination
A Price Index
Measures
the average level of prices
for some specied set of goods and services,
relative to the prices in a specied base year.
Thee major price indices:
1
The Gross Domestic Product (GDP) Deator:
P = 100
nominal GDP
real GDP
2
The Personal Consumption Expenditure (PCE) Deator:
P = 100
nominal PCE
real PCE
3
The Consumer Price Index (CPI).
Measures the average prices of a specied basket of goods and
services bought by consumers.
For a number of technical reasons, it probably overstates the
actual average prices that consumers are paying.
The ination rate is calculated as
t
=
P
t
P
t1
P
t1
=
P
t
P
t1
where
t
the ination rate in period t.
P
t
a price index in period t.
Various measures of the ination rate:
-5
0
5
10
15
20
40 50 60 70 80 90 00 10 20
I
n
f
l
a
t
i
o
n

R
a
t
e

(
%
)
TIME (year)
Source: FRED / BEA & BLS
GDP Price Deflator
Personal Consumption Deflator
Consumer Price Index
Measuring Economic Activity: Unemployment
The unemployment rate is
the percentage of the civilian labor force who are
willing and able to work,
actively looking for work,
not currently employed.
The adult population can be categorized as
1
Employed
2
Unemployed
3
Not in the labor force.
Measures of (Un)employment:
Unemployment Rate
Unemployed
Labor Force
Participation Rate
Labor Force
Population
Employment Ratio
Employed
Population
where
Labor Force Employed + Unemployed
0
2
4
6
8
10
12
40 50 60 70 80 90 00 10 20
C
i
v
i
l
i
a
n

U
n
e
m
p
l
o
y
m
e
n
t

R
a
t
e

(
%
)
TIME (year)
Source: FRED / BLS
55
60
65
70
40 50 60 70 80 90 00 10 20
L
a
b
o
r

F
o
r
c
e

P
a
r
t
i
c
i
p
a
t
i
o
n

R
a
t
i
o

(
%
)
TIME (year)
Source: FRED / BLS
50
55
60
65
40 50 60 70 80 90 00 10 20
E
m
p
l
o
y
m
e
n
t

t
o

P
o
p
u
l
a
t
i
o
n

R
a
t
i
o

(
%
)
TIME (year)
Source: FRED / BLS
0
10
20
30
40
50
40 50 60 70 80 90 00 10 20
U
n
e
m
p
l
o
y
e
d

a
t

l
e
a
s
t

2
7

W
e
e
k
s

(
%
)
TIME (year)
Source: FRED / BLS
Measuring Economic Activity: Interest Rates
An interest rate measures
1
The cost of borrowing.
2
The return to saving and lending.
Interest rates dier due to dierences in
1
maturity,
2
credit risk,
3
liquidity.
Because interest rates are correlated macroeconomic models often
use a single interest rate known as the interest rate.
Nominal and Real ination:
1
The nominal interest rate i is the rate at which the nominal
value of an asset increases over time.
2
The real interest rate r is the rate at which the real value of
an asset increases over time.
3
When the real interest rate r is low
there is greater incentive to borrow and invest, but
there is less incentive to save and lend.
4
Ex-ante real rates are based on expected ination.
5
Ex-post real rate are based on actual ination.
-5
0
5
10
15
40 50 60 70 80 90 00 10 20
R
a
t
e

(
%
)
TIME (year)
Source: FRED / FRB & BLS
10yr Nominal
CPI inflation
10yr Real
10yr TIPS
The Fisher Equation
Is the relationship between the nominal interest rate i , the real
interest rate r , and expected ination
e
:
i = r +
e
We can write the real (ex-ante) interest rate as
r = i
e
.
If we are given the nominal rate and the real (ex-ante) interest
rate, the expected ination follows as
e
= i r .
Measuring Economic Activity: Model Development
Steps in macroeconomic model development:
1
Measuring the macroeconomic data.
2
Looking for patterns in the data.
3
Formulating a theory to explain these patterns.
4
Testing the model against real world experiences.

Lecture2 - Measurement

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