February 28, 2015 Chapter 2: The Data of Macroeconomics Introduction - Our economy is growing and creating jobs at the fastest pace since 1999. - Our unemployment rate is now lower than it was before the financial crisis. - More of our kids are graduating than ever before. - More of our people are insured than ever before. - We are as free from the grip of foreign oil as we’ve been in almost 30 years. - How is the economy doing? - Are we better off than last year? - How do we begin to assess the status of the economy? In this chapter, you will learn……the meaning and measurement of the most important macroeconomic statistics: - National income accounting and Gross Domestic Product (GDP)- The Consumer Price Index (CPI)- The Unemployment Rate Headlines - U.S. Economic activity in non-manufacturing sector grew in August from 52.7% to 53.3%- Growth in pay is crucial for U.S. consumers, whose activity accounts for 70% of the U.S. economic activity. - Economic activity contracted 1.2% in the first quarter…Ways to measure economic activities- How do we measure aggregate economic activity? - Possible answers: o How much has been produced? (output)o How much income has been received? o How much has been spent? - Each question gives us a different perspective on the economy. - What are the relationships among the (three) answers? An example - Data of a US car company - Sales revenue $40,000,000Expenses $26,000,000Wages $20,000,000Cost of Parts $6,000,0000Net Income (Profit) $14,000,000- How much has been produced? o Total car sales: $40,000,000- Parts ($6,000,000) were also produced, but we do not count them, because the value of parts are already reflected in the value of cars - If we did, we would have done something called double accounting- How much income has been received? - Wages $20,000,000Income of Parts Producer $6,000,000Net Income (profit) $14,000,000- Total Income: $40,000,000- How much has been spent? - Total car sales: $40,000,000- Fundamental principle of national income accounting: the product approach, the expenditure approach, and the income approach give identical answers Why are the three measures identical? - Total output (goods and services) equals the amount that buyers must spend to purchase them - Output cannot be added up by quantities (try adding 6 oranges and 3 apples, or 3 PCs and 2 hours of economics lectures)- We must use market value to add them up- Market value makes output = expenditure - What the sellers receive must equal to what the buyers spend - Sales revenues are divided into profits, wages, and payoffs to parts producers - Identity: total production = total expenditure = total income Stock vs. Flows – examples - Stock o A person’s wealth o # of people with college degrees o The gov’t debt - Flow o A person’s annual savings o # of new college graduates this year o The gov’t budged deficit Economic activity measurement - We just used three ways to measure economic activities. - Is this measure a flow, or a stock? - It is a flow, and it is officially called “gross domestic product,” or simply “GDP” Gross Domestic Product: key words- Goods and services- Final goods and services - Market value - Within an economy or country- In a given period of time GDP as a flow - Since GDP is a flow, it captures how active an economy is in a given period of time - It does not tell us how much wealth a nation has - A wealthy nation can have a bad economic performance in a certain period of time - Sometimes, destruction of wealth leads to a lot of economic activities and higher GDP. o Example: hurricanes, wars Three approaches of GDP accounting - There are three approaches to compute GDP: o Product approach o Expenditure approach o Income approach Product Approach - To compute GDP with the product approach, we must understand the concept of “valueadded” Final goods, value added, and GDP - GDP = value of final goods produced = sum of value added at all stages of production - The value of the final goods already includes the value of the intermediate goods, so including intermediate and final goods in GDP would be double-counting Exercise - A farmer grows a bushel of wheat and sells it to a miller for $1.00- The miller turns the wheat into flour and sells it to a baker for $3.00- The baker uses the flour to make a loaf of bread and sells it to an engineer for $6.00- The engineer eats the bread - Compute and compare value added at each state of production and GDP Answers - GDP = value of final goods sold (bread) = $6- GDP = sum of value added = value added by farmer $1 + value added by miller $2 + valueadded by baker $3 = $6 The expenditure approach - Four major components- Consumption- Investment- Government spending- Net exports Investment vs. Capital - Note: investment is spending on new capital - Investment is a flow, while capital is a stock - Example (assumes no depreciation): o 1/1/2014: economy has $500b worth of capital o During 2014: investment = $60bo 1/1/2015: economy will have $560b worth of capital An Important Identity - Y = C + I + G + NX o Y is value of total output o C + I + G + NX is aggregate expenditure eA question for you: Suppose a firm - Produces $10 million worth of final goods - But only sells $9 million worth Does this violate the expenditure = output identity? Why output = expenditure- Unsold output goes into inventory, and is counted as “inventory investment”… whether or not the inventory buildup was intentional - In effect, we are assuming that firms purchase their unsold output Imputed Values - Not all goods and services are sold on the marketplace and have a market value - Examples: services provided by police officers, firefighters, and senators - When you live in a rented apartment, your rent is the market price of the “housing services” you receive. No imputation is necessary. - But what if you own a house? - Economists estimate the rent that homeowners would have paid if they rented their own houses, and include it in consumer expendituresWhat’s left out in GDP calculations - Self service and home production o Examples: the labor services when you mow your own lawn, cook your own meals, and baby-sit your own children - Underground economyo Illegal activities o Legal activities that are not reportedThe income approach - The BEA computes national income, which is the sum of: o Compensation of employeeso Proprietor’s incomeo Rental income o Corporate profits o Net interests o Indirect