Wednesday, April 9, 2008

Lecture 2 - The Data of Macroeconomics


This lecture was highly correlated with the material in Mankiw Chapter 2. See my reading notes on that chapter.

Gross Domestic Product (GDP)

Measure of total production. We also use the GDP as a yardstick against which to measure other indicators.

Only final products are included. Not intermediary products. This prevents double counting. Alternatively, GDP could be calculated by summing all the "value added" amounts. Value-added = value of output - value of intermediary goods.

Determining what is a final product and what is an intermediate good is tricky. An intermediate good is complete used up in producing something else. See Intermediate Consumption in Wikipedia.

Only goods and services that have a market value are included in GDP. Except housing services and govt services. Those are included in GDP. For those, GDP adds an imputed value.

Only new products are included. Not used. That's merely exchange of ownership. However, services provided by car dealerships or other agents to facilitate the sale of used items is included in GDP.

Only domestic products are included in GDP.

Income, Expenditure and Circular Flow

Advanced, preliminary and then revised data is published (by BEA). This is because there are three ways to calculate GDP which are crosschecked against each other.

In the model of a simplified single-item economy, output must equal expenditures.

The components of GDP are:
Private Consumption (C): In US this is 72%. China it's 38%. In Europe it's 50-60%.
Private Investment (I): Not the commonly used term. It means acquisition of physical capital stock like buildings, plants, factories, machinery.
Government Purchases of Goods and Services (G): Deficit means govt spending > tax revenues. The total govt spending includes more than G. It also includes transfer payments like Social Security. It's just redistribution, so it's not included in GDP.
Net Exports (NX): Exports-imports. This takes out the foreign products that were included in C, I, and G.

Imports and Exports (trade volume) are only 30% total of GDP. This contradicts those economists who say that job losses are caused by foreign competition.

Nominal vs Real GDP

Nominal is at current prices. But it can change based on either output or price change.

Question: How do they account for different prices charged by different firms for the same product. Answer: It could be calculated precisely with enough data, but practically speaking it's estimated and crosschecked. Precision is not required because we're just using it to compare to our own other GDP estimates from year to year. See the Methodologies page at BEA for more info.

Real GDP applies constant prices to all years' quantities to get a comparable GDP. For new products, use the current price even for Real GDP.

Chain-weighted method: uses a geometric average to calculate the weighted average for prices. See the article from Miles Cahill of Indiana University on Teaching Chain-Weight Real GDP Measures for a good explanation.

GDP Deflator = Nominal GDP / Real GDP

GDP Deflator is a measure of inflation, but it includes many items that the average consumer doesn't buy.

Consumer Price Index (CPI)

Therefore, the CPI was created to only look at a "basket" of goods purchased by an average consumer.

Inflation Rate

Inflation rate = (CPIcurrent - CPIprevious)/CPIprevious

(multiply by 100 to get a percentage)

CPI vs GDP Deflator

GDP deflator includes more g&s than CPI.
CPI includes imports, GDP deflator doesn't.
CPI basket is fixed, GDP deflator varies.

CPI tends to overstate inflation. GDP deflator tends to understate it.
In reality, consumers change their buying habits based on prices. Their basket varies.

In 1973 and 1978 the CPIrose more sharply than the GDP Deflator due to oil price shock.

Fed looks more at the "core" CPI = CPI-food-energy. For policymaking, they want to look at fundamental items and not at the more volatile items like food and energy.

Social Security benefits are also linked to the CPI.

CPI biases:
Substitution bias (mentioned above)
New products
Change in quality
Outlet mall bias (real consumers may purchase products cheaper from outlet malls)

Research indicated that CPI overstatement is about 1% and recommended that Soc Security be adjusted by CPI-1%. But the recommendation was not implemented.

Many nations target 2% inflation rate. It's because of these biases. If we got anything less than 2%, it might actually be deflation.

Unemployment Rate

Current Population Survey of 60,000 households, monthly. Ages 15-65.

3 categories: Employed, Unemployed, Not in Labor Force

Discouraged workers - They wanted a job, but weren't able to find one and have stopped looking. If they would find a job, they would take it. They're categorized as Not in the Labor Force.

You need to consider these discouraged workers and how they move from one category to another when evaluating the unemployment numbers. When economic conditions improve, discouraged workers often move to the unemployed category, leading to a higher inflation rate.

Military is considered employed.

Okun's Law

Unemployed workers don't contribute to production. Therefore there should be a negative correlation between unemployment and GDP.

Normal GDP growth is 3.3%. For every 1% of increase in the unemployment rate, the real GDP growth falls by 1.86 percentage points.

Reading for next week: Chapter 3.

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