Chapter 2 -- Measuring Output and The Price Level

Data complied at the National Income and Product Accounts (NIPA)

Measuring Output -- Gross Domestic Product (GDP)

Gross Domestic Product -- The total market value of all currently produced final goods and services over a period of time.

Nominal GDP -- GDP in current dollars

Real GDP -- GDP in constant dollars.

Aspects of GDP Definition

“Over a Period of Time” GDP is a flow measure.

“Currently Produced” GDP excludes the following

-- sales of used items

-- transfer payments

-- purchases of stocks, bonds,

or land

“Market Value” -- the transaction must be recorded and have a specific dollar figure attached GDP excludes

-- illegal purchases

-- household production

Final Goods and Services and Measuring GDP

Example -- Production of a pair of shoes.

GDP and Making ShoesStep Value Value Added

Farmer 3 3

Packing Plant 7 4

Tannery 13 6

Shoe

Manufacturer 25 12

Wholesaler 40 15

Retailer 75 35

Total 163 75

What Real GDP (Y) Signifies

Total Production or Output of final goods and services

Total Sales on Final Goods and Services (Approximately)

Total IncomeCorrelated With Total Employment

Computing GDP -- The Expenditure Approach

Operative Equation:

Y = C + I + G + NX

Consumption (C)

Defined as consumer purchases of final goods and services

components of consumption

-- nondurable goods

-- durable goods

-- serviceslargest component of GDP

Investment (I)

Business Purchases of New Plant and Equipment

New Residential HousingChanges In Inventories

Output Versus Sales -- The Approximation

Example -- $18,000 car, produced in 2000, sold in 2001

Year C I G NX Y

2000 $0 $18 $0 $0 $18

2001 $18 -$18 $0 $0 $0

Investment Goods Versus Intermediate Goods

The Similarity -- Transactions between businesses.

The Conceptual Difference -- Producing Final Goods Versus Being Part of a Final Good

The Operational Difference -- Is it used repeated times?

Government Purchases of Goods and Services (G)

Not the same as government expenditure (does not include transfer payments)

In the US, the government is a purchaser, not a producer.

Net Exports (NX)

NX = Exports - Importsexports are all final goods and

servicesGNP versus GDP -- the accounting

of multinational firms

Real GDP and Quality of Life

Real GDP does not account for the following changes:

-- leisure time

-- quality differences

-- crime

-- environmental impacts

More Quality of Life Variables Not in Real GDP

-- non-market production activities

(I) household production

(II) underground economy

-- income distribution

Other Measures of Output or Income

Gross Domestic Product (GDP)

– Depreciation

Net Domestic Product (NDP)

– Indirect Business Taxes

National Income (NI)

National Income

– Undistributed Corporate Profits

(Business Saving)

– Social Security and Corporate Taxes

+ Transfer Payments and Interest

Personal Income (PI)

– Personal Income Taxes

Disposable Income (YD)

Disposable Income and Personal Saving

Define -- Personal Saving (SP)

SP = YD - C

Define -- Total Private Saving (S), S = Personal Saving

+ Business Saving

The “Magic Equation”

Let T = Net Taxes Net Taxes = Tax Revenues - (Transfer

Payments + Interest on the Government Debt)

Then the identity is:

S = I + (G - T) + NX.

Interpreting the Identity: Saving = Investment

Identity: S = I + (G-T) + NX

Rearrange Identity Into:

S + (T - G) + -NX = I

Special Case: (T - G) = 0, NX = 0

S = I

Measuring The Price Level

Measures of the Price Level (P)

-- GDP Deflator

-- Personal Consumption

Expenditure (PCE) Deflator

Measure #1 -- The GDP Deflator

Market Basket -- set of final goods and services that are used to compute GDP.

Chain Weighted Measure -- reduces biases associated with fixed weight index (e.g. Consumer Price Index).

Measure #2 – The PCE Deflator

Market Basket -- set of final goods and services that are used to compute Consumption within GDP.

Chain Weighted Measure -- reduces biases associated with fixed weight index (e.g. Consumer Price Index).

Computing the Inflation Rate

Inflation Rate = Percentage Change or growth in the Price Index (P), such as the GDP Deflator.

Example: Inflation Rate for 2011

Inflation Rate2011 = P2011 – P2010

P2010

Converting Nominal GDP to Real GDP Example -- find Real GDP 2011

Real GDP2011 = Nominal GDP2011

GDP Deflator2011

Real GDP for other years is computed the same way.

Real GDP Growth = Percentage Change (or growth) in Real GDP.

Sources to Obtain Macroeconomic Data

The Economic Report of the

President (Historical Data)

www.gpoaccess.gov/eop/

Economic Indicators (Recent)

www.gpoaccess.gov/indicators/ index.html

More Websites for Macro Data and Information

www.federalreserve.gov (Federal Reserve)

research.stlouisfed.org/fred2/ (Federal Reserve Economic Data)

bea.gov (Bureau of Economic Analysis)

www.bls.gov (Consumer Price Index inflation,

unemployment rate, labor productivity growth)