Wednesday, April 9, 2008

Reading Notes - Chapter 2

The reading assignment for lecture 2 was chapter 2 of Mankiw. The chapter focuses on 3 economic indicators:

Gross Domestic Product (GDP) - reported by the Bureau of Economic Analysis (BEA)
Consumer Price Index (CPI) - reported by the Bureau of Labor Statistics (BLS)
Unemployment Rate - also reported by the BLS

Gross Domestic Product (GDP)

The GDP is the total income of everyone in the economy or, equivalently, the total expenditure on the economy's output of goods and services. For the economy as a whole, income must equal expenditure. GDP measures the flow of dollars in the economy.

There are two types of quantities: stocks and flows. A stock is a quantity measured at a given point in time (e.g. amount of water in a bathtub). A flow is a quantity measured per unit time (e.g. amount of water coming out of a faucet).

More precisely, the GDP is the market value of all final goods and services produced within an economy in a given period of time.

Parse that definition:
Market value - to calculate the GDP, don't count the number of apples or oranges produced. Rather, calculate their market value according to the price of each and compute the sum.
Produced - the sale of used goods is not included in the GDP.
Final Goods and Services - the sale of intermediate goods is not included in the GDP; only final goods.
Produced - Even if not sold. If the product goes into inventory, it is still considered as part of the GDP. When goods are sold from inventory, the sale is added to the GDP, but the reduction in inventory is subtracted.
Produced - The GDP includes some "imputations". These are approximations include services which are not sold on the regular market place. These include housing "services" to homeowners, government services such as police and fire departments. No imputation is made for services for the use of goods other than housing. No imputation is made for household goods and services such as home-made meals. No imputation is made for the underground economy.

Nominal vs Real GDP

The GDP measured at current prices is called nominal GDP. The GDP adjusted for inflation is called the real GDP. In computing Real GDP, a base-year for prices is usually chosen and indicated when reporting.

The Nominal GDP divided by the Real GDP is called the GDP Deflator.

A better way to calculate Real GDP is with a chain-weighted measure. To measure real growth from year X to year X+1, the average prices for those two years are used.
Components of GDP

The four basic components of the GDP are:
Consumption - nondurable goods, durable goods, services
Investment - business fixed investment, residential fixed investment, inventories
Government Purchases - Federal military, Federal non-military, state and local (but not transfer payments like Social Security and welfare)
Net Exports - exports minus imports

GDP is often reported on a per capita basis.

Other Measures

Gross National Product
GNP = GDP + Factor Payments from Abroad - Factor Payments to Abroad

A factor payment from abroad is a payment from someone outside of the economy to someone within the economy. For example, if a US citizen owns a building in London and collects rent on it, those payments are factor payments from abroad. And similarly for factor payments to abroad.

Net National Product
NNP = GNP - Depreciation

(Net) National Income
NNI = NNP - Indirect Business Taxes

Personal Income
Personal Income = National Income
- Corporate Profits
- Social Insurance Contributions
- Net Interest
+ Dividends
+ Government Transfers to Individuals
+ Personal Interest Income

Disposable Personal Income
DPI = Personal Income - Personal Tax - NonTax Gov't Payments

GDP and other economic indicators are usually seasonally adjusted to eliminate the fluctuations due to predictable seasonal changes.

Consumer Price Index (CPI)

Inflation is the increase in the overall level of prices and is measured by the Consumer Price Index (CPI). The CPI is calculated by the "basket of goods and services purchased by a typical consumer" model. Chicken has a higher weight than caviar since people buy more chicken than they do caviar.

There's also a PPI - Producer Price Index - which measures the price of the basket of goods and services purchases by a typical firm.

CPI vs. GDP Deflator

GDP Deflator has all types of goods and services. CPI only has consumer goods and services.
GDP Deflator only has domestic goods and services. CPI has domestic and imported goods and services.
The GDP Deflator "basket" changes as the GDP changes. It's a Paasche index. The CPI "basket" is fixed. It's a Laspeyres index.

A Fisher index is an index that takes the average of a Paasche index and a Laspeyres index.

Problems with the CPI

Many economists believe that the CPI overstates inflation. Some of the problems are:

1. Substitution bias. Consumers may shift and their buying habits based on prices. The fixed basket of the CPI does not take this into account.
2. New goods don't come into the CPI quickly.
3. The quality of the goods is not measured by the CPI.

A 1995 congressional panel concluded that the CPI overstates inflation by 0.8 - 1.6 percent.

Unemployment Rate

The unemployment rate is calculated based on two surveys: The Household Survey and the Establishment Survey.

The Household Survey surveys 60,000 households and gathers responses on the number of people in each household who are employed (anyone with a job), unemployed (anyone without a job but looking for one) and "not in the labor force" (anyone without a job and not looking - students, retirees, homemakers).

Labor Force = Employed + Unemployed

Unemployment Rate = Unemployed/Labor Force

Labor-Force Participation Rate = Labor Force / Total Adult Population

The Establishment Survey comes from the responses of 160,000 businesses about their payroll numbers.

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