II.  Macroeconomics

A.  Measuring Macroeconomic Activity

1.  Gross Domestic Product (GDP)

• Market value of all currently produced final goods and services within a country in a given period of time by domestic and foreign-supplied  resources

a.  Characteristics

• Market value

- Monetary measure

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• Final goods and services

- Sold to end users

$2,000	$5,000	$20,000	$25,000

- Value added approach

+$2,000	+$3,000	+$15,000	+$5,000	= +$25,000

• Currently produced

- Used products not counted

- Products produced but not sold counted

- Financial securities transactions not counted

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• Within a nation

- Measures production within a country's borders, regardless of who produces the products

- Gross National Product (GNP) - market value of final goods and services produced by a nation's resources, regardless of location

IBM plant in China - Counted in Chinese GDP - Counted in U.S. GNP		Toyota plant in U.S. - Counted in U.S. GDP - Counted in Japanese GNP

• During a period of time

- Flow variable

- Reported on quarterly basis, also annual basis

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• Nonmarket transactions not counted

- Legal (e.g., housework) and illegal (e.g., drug trafficking), cash economy

- Imputed value of some nonmarket transactions included

Ex.- Owner-occupied housing

$0	$2,500
$2,500	$2,500

• Transfer payments not counted

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• Leisure and quality of life not considered

Ex. -

- 100 hours a week, $500,000 a year

- 60 hours a week, $250,000 a year

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•  Harmful and dangerous output counted the same as useful output

- Natural disasters, wars, environmental disasters counted as increasing GDP

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b.  Real  vs. nominal GDP

• Real GDP - takes price changes into account

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• Nominal GDP = ∑ Q_T * P_T

Ex. -

Nominal GDP (2008) = (5,000,000 * $10) + (10,000 * $20,000) + (1,500,000 * $100) = $400 million

Nominal GDP (2018) = (6,000,000 * $7.50) + (12,000 * $25,000) + (2,000,000 * $150) = $645 million

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• Real GDP = ∑  Q_T  * P_B

Ex. -

Real GDP (2008) = (5,000,000 * $10) + (10,000 * $20,000) + (1,500,000 * $100) = $400 million

Real GDP (2018) = (6,000,000 * $10) + (12,000 * $20,000) + (2,000,000 * $100) = $500 million

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• GDP deflator - used to measure changes in prices (inflation)

GDP deflator = nominal GDP / real GDP *100

Ex. -

GDP deflator (2008) = $400 million / $400 million * 100 = 100.0

GDP deflator (2018) = $645 million / $500 million * 100 = 129.0

=> 29 percent inflation between 2008 and 2018

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c.  Circular flow model

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d.  Expenditure or output approach

• Measure the expenditures on output produced in the economy

• Calculated by the Bureau of Economic Analysis

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(1)  Personal consumption expenditures (C)

• Durable goods - last more than three years

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• Nondurable goods - last less than three years

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• Services - noncommodity items

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(2)  Gross private domestic investment spending (I)

• Business fixed investment

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• Residential fixed investment

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• Changes in business inventory

GDP = +5	C = +3	I = +2
GDP = +3	C = +4	=> I = -1

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(3)  Government consumption expenditures and gross investment (G)

• Federal vs. state and local

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• Consumption vs. investment

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(4)  Net exports (X - M)

• Exports (X)

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• Imports (M)

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• GDP (Y) = C + I + G + (X - M)

e.  Income or earnings approach

• Measure the earnings or income generated by selling the output produced in the economy

• National income - income generated from the sale of goods and services produced in an economy and paid to the factors of production

(1) Compensation of employees (W) - wages, salaries, beneftis

(2) Proprietor's income (Prop Y)

(3)  Rental income (R)

(4)  Corporate profits (π)

(5) Net interest (i) - interest earned minus interest paid

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• GDP accounting

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GDP = C + I + G + (X - M)

- Depreciation

National income (NI) = W + Prop Y + R + π + i

- Income earned but not received

+ Income received but not earned

Personal income (PI)

- Personal taxes (T_P)

Disposable personal income (DPI) = C + S

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Ex. - 2017

C = 13,396

I = 3,213

G = 3,354

X = 2,344

M = 2,916

Depreciation = 3,035

W = 10,307

Prop Y = 1,386

R = 744

π = 2,165

i = 586

Income earned but not received = 1,302

Income received but not earned = 2,850

T_P = 2,854

S = 486

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2.  Price level measures

• Inflation - a sustained increase in the price level over time

• Deflation - a sustained decrease in the price level over time

a.  Inflation measures

(1)  GDP Price Deflator

• GDP deflator = nominal GDP / real GDP *100

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(2)  Consumer Price Index (CPI)

• Measure of the weighted-average change in prices for a market basket of goods and services purchased by a typical urban family of four 

• Compare prices in given year to prices in a base year

(a)  Calculation

CPI = ∑ Q_B * P_T / ∑ Q_B * P_B * 100

Ex. -

CPI (2017) = [ (28 * $5) + (10 * 16) + (1 * $500) ] / [ (28 * $5) + (10 * 16) + (1 * $500) ]  * 100 = 100.00

CPI (2018) = [ (28 * $3) + (10 * 20) + (1 * $550) ] / [ (28 * $5) + (10 * 16) + (1 * $500) ]  * 100 = 104.25

=> 4.25 percent inflation between 2017 and 2018

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CPI (2019) = 108.00 => Inflation = (108.00 - 104.25) / 104.25 = 0.036 or 3.6 percent

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• Bureau of Labor Statistics

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(b) Problems with using the CPI

i)  Substitution bias

• Different products used when price increases

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ii) Inadequate treatment of quality changes

• Part of price increase due to increase in quality

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iii) New products not counted

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(c)  Core rate of inflation

• Take food and energy out of market basket

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(3)  Producer Price Index

• Measures price changes at the wholesale level

• Measures prices firms pay for:

- Crude materials for further processing

- Intermediate materials, supplies, and components

- Finished goods

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• Calculated by the Bureau of Labor Statistics

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(4)  Employment Cost Indexes

• Weighted-average cost of an hour of labor

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(5)  Personal Consumption Expenditure Price Index

• Measures changes in domestic consumer goods and services purchased by household sector

• Federal Reserve now uses PCE as target instead of CPI

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b.  Real values

• Adjust nominal values for inflation

Real value = (Nominal value / Price index) * 100

Ex. - Income = $70,000 in 2018

Real value = ($70,000 / 104.25) * 100 = $67,146.28

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3.  Measures of employment and unemployment

• Calculated by the Bureau of Labor Statistics

- Current Population Survey (Household Survey) - monthly survey of 60,000 households to estimate unemployment rate

- Establishment Survey - monthly survey of 160,000 businesses and government agencies from a database of 400,000 existing worksites to estimate employment growth

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a.  Unemployment rate

• Unemployed - not working, available to work, actively seeking employment in last four weeks

• "Actively seeking employment" - register at a public or private employment office, meet with prospective employers, place or answer job advertisement, write letters of application, be on a union or professional register, or check with friends and relatives for job opportunities

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• Employed - persons who did any work as paid employees, worked in own business, worked in nonpaying family business at least 15 hours per week, and those temporarily absent from jobs

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• Labor force = employed + unemployed

- Excludes people in institutions, children, people in armed forces, those not seeking work (homemakers, students, etc.)

- Excludes discouraged workers - people who previously worked but are not currently seeking work because of economic concerns

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• Unemployment rate = number of unemployed / labor force

Ex. - March 2018 unemployment rate = 6,585 / 161,763 = 4.1%

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b.  Other measures of labor underutilization

(1)  U3 - unemployment rate

(2)  U4 - includes discouraged workers

(3)  U5 - includes marginally attached (broader category of discouraged workers)

(4)  U6 - includes those working part-time who want a full-time job

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c.  Labor force participation rate

• Proportion of the working age population that is in the labor force

• Labor force participation rate (LFPR) = labor force / noninstitutional population 16 and over = (employed + unemployed) / noninstitutional population 16 and over

Ex. - March 2018 LFPR = 161,763 / 257,097 = 62.9%

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d.  Employment-population ratio

• Proportion of the noninstitutional population 16 and over that is employed

• Employment-population ratio = number employed / noninstitutional population 16 and over

Ex. - March 2018 employment-population ratio = 155,178 / 257,097 = 60.4%

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e.  Natural rate of unemployment

• Minimum level of unemployment that can be achieved without causing inflation to accelerate

• About 4.0 - 4.5% in the U.S.

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