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Chapter 2 The Measurement and Structure  of the National Economy
National Income Accounting <ul><li>National income accounts : an accounting framework used in measuring current economic a...
How to measure economic activity ?   Producers Consumers $ Output Produced Incomes received Expenditures
How to measure economic activity ?   <ul><li>Product Approach :  measure the amount of  output produced , excluding output...
How to measure economic activity ?   <ul><li>In principle, the 3 approaches should yield the same measurement of current e...
An Example   OrangeInc JuiceInc Consumers $ orange orange $ juice
An Example   <ul><li>OrangeInc Transactions </li></ul><ul><li>Wage bill    $15,000 </li></ul><ul><li>Tax payment  $ 5,000 ...
An Example :  Income Approach <ul><li>The income approach measures economic activity by adding all income generated by pro...
An Example: Income Approach   <ul><li>OrangeInc Transactions </li></ul><ul><li>Wage bill    $15,000 </li></ul><ul><li>Tax ...
An Example :  Income Approach <ul><li>Total Income: </li></ul><ul><li>Profits for OrangeInc  $ 15,000 </li></ul><ul><li>Pr...
An Example: Expenditure Approach <ul><li>The expenditure approach measures activity by adding the amount spent by all  ult...
An Example :  Product Approach <ul><li>The product approach measures the amount of output produced, excluding output used ...
An Example :  Product Approach <ul><li>For JuiceInc,   </li></ul>Revenue / Output $40,000 Oranges $25,000 Value-added $15,...
An Example :  Product Approach <ul><li>The  value added  of any producer is the value of its output minus the value of the...
An Example: Product Approach   <ul><li>OrangeInc Transactions </li></ul><ul><li>Wage bill    $15,000 </li></ul><ul><li>Tax...
Gross Domestic Product (GDP) <ul><li>GDP is the most commonly used measure of aggregate economic activity.  </li></ul><ul>...
Nominal GDP of the U.S., 1930-2006
GDP: Income Approach <ul><ul><li>The  income approach  calculates GDP by adding the incomes received by producers, includi...
GDP: Income Approach <ul><ul><li>Compensation of employees  is the  before-tax  income of workers (excluding the self-empl...
GDP: Income Approach <ul><ul><li>Taxes on production and imports  include indirect business taxes (such as sales taxes) as...
GDP: Income Approach <ul><ul><li>Rental income of persons </li></ul></ul><ul><ul><li>Business current transfer payments </...
GDP: Expenditure Approach <ul><li>The expenditure approach measures GDP as total spending on final goods and services  pro...
Table 2.1  Expenditure Approach to Measuring GDP in the United States, 2005
GDP: Expenditure Approach <ul><li>Consumption:  spending by  domestic households  on  final goods and services , including...
GDP: Expenditure Approach <ul><li>Q: In the definition, you said we only count the spending on final goods and services  p...
GDP: Expenditure Approach Domestic Producers Foreign Producers Domestic Households Foreign Households (1) (2) (3) (4) Impo...
GDP: Expenditure Approach <ul><li>Investment:   </li></ul><ul><ul><li>Fixed investment:  spending for new capital goods </...
GDP: Expenditure Approach <ul><li>Government purchases of goods and services : any expenditure by the government for a cur...
GDP: Product Approach <ul><li>Product Approach : </li></ul><ul><ul><li>The product approach defines a nation’s GDP as the ...
GDP: Product Approach <ul><li>Market value (or current value):  </li></ul><ul><ul><li>the value of goods and services at t...
GDP: Product Approach <ul><li>Market value: </li></ul><ul><ul><li>Q: What if some commodities are not sold in formal marke...
GDP: Product Approach <ul><li>Final goods and services:  </li></ul><ul><ul><li>Intermediate goods  are those  used up  in ...
GDP: Product Approach <ul><li>Final goods and services:  </li></ul><ul><ul><li>Inventories  are stock of unsold finished g...
GDP: Product Approach <ul><li>Q: Which of the following is included in the GDP of 2006 ? </li></ul><ul><ul><li>The sale of...
Real vs Nominal GDP  <ul><ul><li>So far, all the components in GDP are measured in terms of  current market values  (curre...
Real GDP: An Example <ul><ul><li>2005  2006 </li></ul></ul><ul><li>Quantity   </li></ul><ul><li>Computers  5  10 </li></ul...
Real GDP: An Example <ul><li>Percentage change of Nominal GDP  </li></ul><ul><ul><li>from 2005 to 2006 </li></ul></ul><ul>...
Real GDP & Price Indices <ul><ul><li>To remove the effects of price changes: </li></ul></ul><ul><ul><ul><li>Pick one year ...
Real GDP: An Example <ul><ul><li>2005  (Base Year)   2006 </li></ul></ul><ul><li>Quantity   </li></ul><ul><li>Computers  5...
Real GDP: An Example <ul><ul><li>2005   2006  (Base Year)   </li></ul></ul><ul><li>Quantity   </li></ul><ul><li>Computers ...
Real GDP: An Example <ul><ul><li>2005   2006  % change </li></ul></ul><ul><li>Nominal GDP  $ 46,000  $ 66,000   43.5%   </...
Real GDP: An Example <ul><li>% change of Nominal GDP =  43.5% </li></ul><ul><li>% change of Real GDP using 2005 as base ye...
Real and Nominal GDP in the U.S., 1930-2006 . Real GDP Nominal GDP
Real vs Nominal GDP  <ul><li>To summarize: </li></ul><ul><ul><li>Real GDP measures the physical volume of an economy’s fin...
Price Indexes & Inflation <ul><li>A  price index  is a measure of the average level of prices  for some specified set of g...
GDP Deflator <ul><li>The  GDP deflator  is a price index that measures the overall level of prices of goods and services i...
GDP Deflator: An Example <ul><ul><li>2005   2006  % change </li></ul></ul><ul><li>Nominal GDP  $ 46,000  $ 66,000   43.5% ...
Consumer Price Index (CPI)  <ul><li>CPI measures the prices of  consumer goods .  </li></ul><ul><li>Every month the Bureau...
Consumer Price Index (CPI)  <ul><li>The CPI is intended to reflect the costs of living.  </li></ul><ul><li>Many government...
Consumer Price Index (CPI)  <ul><li>This can arise when the CPI fails to account for quality improvements in goods and ser...
Consumer Price Index (CPI)  <ul><li>Monthly data on the CPI can be obtained from the following website: </li></ul><ul><li>...
What we have learned in this chapter ?   <ul><li>The 3 approaches to measure economic activity, namely the product approac...
Preparing for the Quiz <ul><li>Be familiar with the following concepts:  </li></ul><ul><ul><li>Product, income and expendi...
Preparing for the Quiz <ul><li>Know the differences between </li></ul><ul><ul><li>Intermediate goods vs Capital goods </li...
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Chapter 2

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Transcript of "Chapter 2"

  1. 1. Chapter 2 The Measurement and Structure of the National Economy
  2. 2. National Income Accounting <ul><li>National income accounts : an accounting framework used in measuring current economic activity. </li></ul><ul><li>These accounts are set up in a way that mirrors the structure of the economy, so they help us understand how the macroeconomy works. </li></ul>
  3. 3. How to measure economic activity ? Producers Consumers $ Output Produced Incomes received Expenditures
  4. 4. How to measure economic activity ? <ul><li>Product Approach : measure the amount of output produced , excluding output used up in intermediate stages of production. </li></ul><ul><li>Income Approach : measure the incomes received by the producers of output. </li></ul><ul><li>Expenditure Approach : measure the amount of spending by the ultimate purchasers of output. </li></ul>
  5. 5. How to measure economic activity ? <ul><li>In principle, the 3 approaches should yield the same measurement of current economic activity. </li></ul><ul><li>In practice, there might be some discrepancies due to incomplete or misreported data. </li></ul>
  6. 6. An Example OrangeInc JuiceInc Consumers $ orange orange $ juice
  7. 7. An Example <ul><li>OrangeInc Transactions </li></ul><ul><li>Wage bill $15,000 </li></ul><ul><li>Tax payment $ 5,000 </li></ul><ul><li>Revenue </li></ul><ul><li>Orange sold to public $10,000 </li></ul><ul><li>Orange sold to JuiceInc $ 25,000 </li></ul><ul><li>Total $ 35,000 </li></ul><ul><li>JuiceInc Transactions </li></ul><ul><li>Wage bill $ 10,000 </li></ul><ul><li>Tax payment $ 2,000 </li></ul><ul><li>Oranges purchased </li></ul><ul><li>from OrangeInc $ 25,000 </li></ul><ul><li>Revenue $ 40,000 </li></ul>
  8. 8. An Example : Income Approach <ul><li>The income approach measures economic activity by adding all income generated by production, including </li></ul><ul><ul><li>wages received by workers </li></ul></ul><ul><ul><li>(after-tax) profits received by owners of firms </li></ul></ul><ul><ul><li>tax revenues received by the government </li></ul></ul>
  9. 9. An Example: Income Approach <ul><li>OrangeInc Transactions </li></ul><ul><li>Wage bill $15,000 </li></ul><ul><li>Tax payment $ 5,000 </li></ul><ul><li>Revenue </li></ul><ul><li>Orange sold to public $10,000 </li></ul><ul><li>Orange sold to JuiceInc $ 25,000 </li></ul><ul><li>Total $ 35,000 </li></ul><ul><li>Profits = Revenue - wage - tax </li></ul><ul><li>= $ 35,000 - $15,000 - $5,000 </li></ul><ul><li>= $ 15,000 </li></ul><ul><li>JuiceInc Transactions </li></ul><ul><li>Wage bill $ 10,000 </li></ul><ul><li>Tax payment $ 2,000 </li></ul><ul><li>Oranges purchased </li></ul><ul><li>from OrangeInc $ 25,000 </li></ul><ul><li>Revenue $ 40,000 </li></ul><ul><li>Profits = Revenue – wage – inputs </li></ul><ul><li>- tax </li></ul><ul><li>= $ 3,000 </li></ul>
  10. 10. An Example : Income Approach <ul><li>Total Income: </li></ul><ul><li>Profits for OrangeInc $ 15,000 </li></ul><ul><li>Profits for JuiceInc $ 3,000 </li></ul><ul><li>Wage received by </li></ul><ul><li>OrangeInc Employees $ 15,000 </li></ul><ul><li>Wage received by </li></ul><ul><li>JuiceInc Employees $ 10,000 </li></ul><ul><li>Taxes from OrangeInc $ 5,000 </li></ul><ul><li>Taxes from JuiceInc $ 2,000 </li></ul><ul><li>Total $ 50,000 </li></ul>
  11. 11. An Example: Expenditure Approach <ul><li>The expenditure approach measures activity by adding the amount spent by all ultimate users of output. </li></ul><ul><li>In this example, the ultimate users are the consumers. </li></ul><ul><li>Total Expenditures </li></ul><ul><ul><li>Buy oranges from OrangeInc $ 10,000 </li></ul></ul><ul><ul><li>Buy juices from JuiceInc $ 40,000 </li></ul></ul><ul><ul><li>Total $ 50,000 </li></ul></ul>
  12. 12. An Example : Product Approach <ul><li>The product approach measures the amount of output produced, excluding output used up in intermediate stages of production. </li></ul><ul><li>Q: In this example, is this the same as adding up the revenues of the OrangeInc and JuiceInc ? </li></ul><ul><li>A: NO. </li></ul>
  13. 13. An Example : Product Approach <ul><li>For JuiceInc, </li></ul>Revenue / Output $40,000 Oranges $25,000 Value-added $15,000
  14. 14. An Example : Product Approach <ul><li>The value added of any producer is the value of its output minus the value of the inputs it purchases from other producers ( intermediate goods ). </li></ul><ul><li>The product approach computes economic activity by summing the value added by all producers. </li></ul>
  15. 15. An Example: Product Approach <ul><li>OrangeInc Transactions </li></ul><ul><li>Wage bill $15,000 </li></ul><ul><li>Tax payment $ 5,000 </li></ul><ul><li>Revenue </li></ul><ul><li>Orange sold to public $10,000 </li></ul><ul><li>Orange sold to JuiceInc $ 25,000 </li></ul><ul><li>Total $ 35,000 </li></ul><ul><li>Value-added $ 35,000 </li></ul><ul><li>JuiceInc Transactions </li></ul><ul><li>Wage bill $ 10,000 </li></ul><ul><li>Tax payment $ 2,000 </li></ul><ul><li>Oranges purchased </li></ul><ul><li>from OrangeInc $ 25,000 </li></ul><ul><li>Revenue $ 40,000 </li></ul><ul><li>Value-added $40,000-$25,000 </li></ul><ul><li>= $15,000 </li></ul>Total value added = $50,000
  16. 16. Gross Domestic Product (GDP) <ul><li>GDP is the most commonly used measure of aggregate economic activity. </li></ul><ul><li>GDP data can be obtained from the following website: </li></ul><ul><ul><li>http:// www.bea.gov/national/index.htm#gdp </li></ul></ul>
  17. 17. Nominal GDP of the U.S., 1930-2006
  18. 18. GDP: Income Approach <ul><ul><li>The income approach calculates GDP by adding the incomes received by producers, including profits, and taxes paid to the government. </li></ul></ul><ul><ul><li>8 categories of income </li></ul></ul>
  19. 19. GDP: Income Approach <ul><ul><li>Compensation of employees is the before-tax income of workers (excluding the self-employed). [57% of GDP in 2005.] </li></ul></ul><ul><ul><li>Corporate Profits represent the remainder of the corporate revenue after wages, interest, rents and other costs have been paid but before taxes have been paid. [10.8% of GDP in 2005.] </li></ul></ul><ul><ul><li>Proprietor’s income is the income of the non-incorporated self-employed. [7.5% of GDP in 2005.] </li></ul></ul>
  20. 20. GDP: Income Approach <ul><ul><li>Taxes on production and imports include indirect business taxes (such as sales taxes) as well as custom duties and taxes on residential real estate. [6.8% of GDP in 2005.] </li></ul></ul><ul><ul><li>Net interest is interest earned by individuals from businesses and foreign sources minus interest paid by individuals. [4.0% of GDP in 2005.] </li></ul></ul>
  21. 21. GDP: Income Approach <ul><ul><li>Rental income of persons </li></ul></ul><ul><ul><li>Business current transfer payments </li></ul></ul><ul><ul><li>Current surplus of government enterprises. </li></ul></ul><ul><ul><li>(See Chapter 2 for details) </li></ul></ul>
  22. 22. GDP: Expenditure Approach <ul><li>The expenditure approach measures GDP as total spending on final goods and services produced within a nation during a specified period of time. </li></ul><ul><li>4 major categories of spending: </li></ul><ul><ul><li>Consumption (C) </li></ul></ul><ul><ul><li>Investment (I) </li></ul></ul><ul><ul><li>Government purchases of goods and services (G) </li></ul></ul><ul><ul><li>Net exports (NX) </li></ul></ul><ul><li>Income-expenditure identity: </li></ul><ul><li>Y = C + I + G + NX </li></ul>
  23. 23. Table 2.1 Expenditure Approach to Measuring GDP in the United States, 2005
  24. 24. GDP: Expenditure Approach <ul><li>Consumption: spending by domestic households on final goods and services , including those produced abroad (i.e. imports). </li></ul><ul><li>3 categories of consumption spending: </li></ul><ul><ul><li>Consumer durables , e.g. cars, DVD players, ipod. </li></ul></ul><ul><ul><li>Nondurable goods , e.g. food, clothing. </li></ul></ul><ul><ul><li>Services , e.g. education, health care, transportation. </li></ul></ul>
  25. 25. GDP: Expenditure Approach <ul><li>Q: In the definition, you said we only count the spending on final goods and services produced within a nation . But now you said we also include imports in the consumption component. </li></ul><ul><li>A: We include imports in Consumption (C) but we take these out in Net Exports (NX). So imports are cancelled out in C + NX. </li></ul>
  26. 26. GDP: Expenditure Approach Domestic Producers Foreign Producers Domestic Households Foreign Households (1) (2) (3) (4) Import = (2) Export = (3) Consumption (C) = (1) + (2) Net Export (NX) = (3) – (2) C + NX = (1) + (3)
  27. 27. GDP: Expenditure Approach <ul><li>Investment: </li></ul><ul><ul><li>Fixed investment: spending for new capital goods </li></ul></ul><ul><ul><ul><li>Business fixed investment : spending by businesses on structures, equipment and software etc.. </li></ul></ul></ul><ul><ul><ul><li>Residential investment : spending on the construction of new houses and apartment buildings. </li></ul></ul></ul><ul><ul><ul><li>How about investment made by the government ? </li></ul></ul></ul><ul><ul><li>Inventory investment: increases in firm’s inventory holdings. </li></ul></ul>
  28. 28. GDP: Expenditure Approach <ul><li>Government purchases of goods and services : any expenditure by the government for a currently produced good or service, foreign or domestic. </li></ul><ul><li>Not all government spending is included in here </li></ul><ul><ul><li>Transfers (such as Social Security and Medicare benefits, welfare payments) are excluded. </li></ul></ul><ul><ul><li>Interest payments on the national debt are also excluded. </li></ul></ul>
  29. 29. GDP: Product Approach <ul><li>Product Approach : </li></ul><ul><ul><li>The product approach defines a nation’s GDP as the market value of final goods and services newly produced within a nation during a fixed period to time. </li></ul></ul>
  30. 30. GDP: Product Approach <ul><li>Market value (or current value): </li></ul><ul><ul><li>the value of goods and services at the prices at which they are sold ( market prices ). </li></ul></ul><ul><ul><li>If we think of market-determined prices as measures of relative economic values , then using market value to measure production will take into account differences in the relative economic importance of different items. </li></ul></ul>
  31. 31. GDP: Product Approach <ul><li>Market value: </li></ul><ul><ul><li>Q: What if some commodities are not sold in formal markets ? </li></ul></ul><ul><ul><li>A: They are either not included or only partially included in GDP. </li></ul></ul><ul><ul><li>Examples: </li></ul></ul><ul><ul><li>Child care performed within the family without pay. </li></ul></ul><ul><ul><li>Activities that improve the environment. </li></ul></ul><ul><ul><li>Activities in the underground economy. </li></ul></ul>
  32. 32. GDP: Product Approach <ul><li>Final goods and services: </li></ul><ul><ul><li>Intermediate goods are those used up in the production of other goods in the same period that they themselves were produced. </li></ul></ul><ul><ul><li>Capital good : good that is itself produced, used to produce other goods but is not used up in the same period that it is produced. Examples: buildings, machinery, software. </li></ul></ul><ul><ul><li>Capital goods are classified as final goods in the national income accounts. </li></ul></ul>
  33. 33. GDP: Product Approach <ul><li>Final goods and services: </li></ul><ul><ul><li>Inventories are stock of unsold finished goods and raw materials held by firms. </li></ul></ul><ul><ul><li>Inventory investment is the amount by which inventories increase during the year. </li></ul></ul><ul><ul><li>Inventory investment is treated as final good. </li></ul></ul>
  34. 34. GDP: Product Approach <ul><li>Q: Which of the following is included in the GDP of 2006 ? </li></ul><ul><ul><li>The sale of a car produced in 2006. </li></ul></ul><ul><ul><li>The sale of a used car in 2006. </li></ul></ul><ul><ul><li>The sale of an unused car from a </li></ul></ul><ul><ul><li>manufacturer’s inventory. </li></ul></ul><ul><ul><li>The sale of a machine used to produce </li></ul></ul><ul><ul><li>cars. </li></ul></ul><ul><ul><li>Services provided by private day-care </li></ul></ul><ul><ul><li>center. </li></ul></ul>YES NO NO YES YES
  35. 35. Real vs Nominal GDP <ul><ul><li>So far, all the components in GDP are measured in terms of current market values (current prices). </li></ul></ul><ul><ul><li>Such variables are called nominal variables . </li></ul></ul><ul><ul><li>Changes in nominal GDP over time can be due to </li></ul></ul><ul><ul><ul><li>Changes in the prices of goods and services </li></ul></ul></ul><ul><ul><ul><li>Changes in the quantities </li></ul></ul></ul><ul><ul><li>How can we remove the effects of price changes ? </li></ul></ul>
  36. 36. Real GDP: An Example <ul><ul><li>2005 2006 </li></ul></ul><ul><li>Quantity </li></ul><ul><li>Computers 5 10 </li></ul><ul><li>Bicycles 200 250 </li></ul><ul><li>Price </li></ul><ul><li>Computers $1,200@ $600@ </li></ul><ul><li>Bicycles $200@ $240@ </li></ul><ul><li>Value </li></ul><ul><li>Computers 5 x $1200 = $6,000 10 x $600 = $6,000 </li></ul><ul><li>Bicycles 200 x $200 = $40,000 250 x $240 = $60,000 </li></ul><ul><li>Nominal GDP $6,000 + $40,000 $6,000 + $ 60,000 </li></ul><ul><li>= $46,000 = $ 66,000 </li></ul>
  37. 37. Real GDP: An Example <ul><li>Percentage change of Nominal GDP </li></ul><ul><ul><li>from 2005 to 2006 </li></ul></ul><ul><ul><li>New Value – Old Value </li></ul></ul><ul><ul><li>Old Value </li></ul></ul><ul><ul><li>$ 66,000 - $ 46,000 </li></ul></ul><ul><ul><li>$ 46,000 </li></ul></ul><ul><ul><li>= 43.5% </li></ul></ul>x 100% = = x 100%
  38. 38. Real GDP & Price Indices <ul><ul><li>To remove the effects of price changes: </li></ul></ul><ul><ul><ul><li>Pick one year as the base year </li></ul></ul></ul><ul><ul><ul><li>Calculate the value of production in each year by using the prices from the base year. </li></ul></ul></ul>
  39. 39. Real GDP: An Example <ul><ul><li>2005 (Base Year) 2006 </li></ul></ul><ul><li>Quantity </li></ul><ul><li>Computers 5 10 </li></ul><ul><li>Bicycles 200 250 </li></ul><ul><li>Price </li></ul><ul><li>Computers $1,200@ $1,200@ </li></ul><ul><li>Bicycles $200@ $200@ </li></ul><ul><li>Value </li></ul><ul><li>Computers 5 x $1200 = $6,000 10 x $1,200 = $12,000 </li></ul><ul><li>Bicycles 200 x $200 = $40,000 250 x $200 = $50,000 </li></ul><ul><li>Real GDP $6,000 + $40,000 $12,000 + $ 50,000 </li></ul><ul><li>= $46,000 = $ 62,000 </li></ul><ul><li>(No change) </li></ul>
  40. 40. Real GDP: An Example <ul><ul><li>2005 2006 (Base Year) </li></ul></ul><ul><li>Quantity </li></ul><ul><li>Computers 5 10 </li></ul><ul><li>Bicycles 200 250 </li></ul><ul><li>Price </li></ul><ul><li>Computers $600@ $600@ </li></ul><ul><li>Bicycles $240@ $240@ </li></ul><ul><li>Value </li></ul><ul><li>Computers 5 x $600 = $3,000 10 x $600 = $6,000 </li></ul><ul><li>Bicycles 200 x $240 = $48,000 250 x $240 = $60,000 </li></ul><ul><li>Real GDP $3,000 + $48,000 $12,000 + $ 50,000 </li></ul><ul><li>= $51,000 = $ 62,000 </li></ul><ul><li>(No change) </li></ul>
  41. 41. Real GDP: An Example <ul><ul><li>2005 2006 % change </li></ul></ul><ul><li>Nominal GDP $ 46,000 $ 66,000 43.5% </li></ul><ul><li>Real GDP $ 46,000 $ 62,000 34.8% </li></ul><ul><li>(Base year = 2005) </li></ul><ul><li>Real GDP $ 51,000 $ 66,000 29.4% </li></ul><ul><li>(Base year = 2006) </li></ul>
  42. 42. Real GDP: An Example <ul><li>% change of Nominal GDP = 43.5% </li></ul><ul><li>% change of Real GDP using 2005 as base year </li></ul><ul><ul><li>$ 62,000 - $ 46,000 </li></ul></ul><ul><ul><li>$ 46,000 </li></ul></ul><ul><li>% change of Real GDP using 2006 as base year </li></ul><ul><li>$ 66,000 - $ 51,000 </li></ul><ul><li>$ 51,000 </li></ul>x 100% = 34.8 % = = x 100% = 29.4 %
  43. 43. Real and Nominal GDP in the U.S., 1930-2006 . Real GDP Nominal GDP
  44. 44. Real vs Nominal GDP <ul><li>To summarize: </li></ul><ul><ul><li>Real GDP measures the physical volume of an economy’s final production using the prices of a base year. </li></ul></ul><ul><ul><li>Nominal GDP is the dollar value of an economy’s final output measured at current market prices. </li></ul></ul><ul><ul><li>Nominal GDP = Real GDP for the base year. </li></ul></ul>
  45. 45. Price Indexes & Inflation <ul><li>A price index is a measure of the average level of prices for some specified set of goods and services , relative to the prices in a specified base year. </li></ul><ul><li>Inflation is the percentage change in the price index per period. </li></ul><ul><li>Two most common price indexes: </li></ul><ul><ul><li>GDP Deflator </li></ul></ul><ul><ul><li>Consumer Price Index (CPI) </li></ul></ul>
  46. 46. GDP Deflator <ul><li>The GDP deflator is a price index that measures the overall level of prices of goods and services included in GDP. </li></ul><ul><li>Like real GDP, the measurement of the GDP deflator depends on the choice of a base year. </li></ul>GDP Deflator = Nominal GDP Real GDP x 100
  47. 47. GDP Deflator: An Example <ul><ul><li>2005 2006 % change </li></ul></ul><ul><li>Nominal GDP $ 46,000 $ 66,000 43.5% </li></ul><ul><li>Real GDP $ 46,000 $ 62,000 34.8% </li></ul><ul><li>(Base year = 2005) </li></ul><ul><li>GDP Deflator 100 106.5 6.5% </li></ul><ul><li> (Inflation) </li></ul>
  48. 48. Consumer Price Index (CPI) <ul><li>CPI measures the prices of consumer goods . </li></ul><ul><li>Every month the Bureau of Labor Statistics collect the current prices of a fixed basket of consumer goods an services such as food, housing and fuel. </li></ul><ul><li>The BLS also collects information on consumers’ expenditure patterns. </li></ul><ul><li>This information is used to weight the prices. </li></ul>
  49. 49. Consumer Price Index (CPI) <ul><li>The CPI is intended to reflect the costs of living. </li></ul><ul><li>Many government payments and taxes are tied, or indexed, to the CPI. For example, social security benefits are raised every year by the same % as the CPI. </li></ul><ul><li>But there are reasons to believe that increases in the CPI might overstate the actual rate at which the cost of living rises. </li></ul>
  50. 50. Consumer Price Index (CPI) <ul><li>This can arise when the CPI fails to account for quality improvements in goods and services. </li></ul><ul><li>Example: </li></ul><ul><ul><li>The processing speed of computer is increased by 10% and the price of computer increases accordingly. </li></ul></ul><ul><ul><li>The price increase should not be considered as an increase in the cost of living. </li></ul></ul><ul><ul><li>If the BLS fail to account for the improved quality of computer but simply note the price increase, then the price change will be incorrectly interpreted as inflation. </li></ul></ul>
  51. 51. Consumer Price Index (CPI) <ul><li>Monthly data on the CPI can be obtained from the following website: </li></ul><ul><li>http:// www.bls.gov </li></ul>
  52. 52. What we have learned in this chapter ? <ul><li>The 3 approaches to measure economic activity, namely the product approach, the income approach and the expenditure approach. </li></ul><ul><li>How to use these approaches to measure GDP. </li></ul><ul><li>Real vs Nominal GDP </li></ul>
  53. 53. Preparing for the Quiz <ul><li>Be familiar with the following concepts: </li></ul><ul><ul><li>Product, income and expenditure approach </li></ul></ul><ul><ul><li>Value added of producers </li></ul></ul><ul><ul><li>Intermediate goods </li></ul></ul><ul><ul><li>Capital goods </li></ul></ul><ul><ul><li>Inventory and inventory investment </li></ul></ul><ul><ul><li>Consumption, investment, government purchases and net export (GDP = C + I + G + NX) </li></ul></ul><ul><ul><li>Market value of final goods and services </li></ul></ul><ul><ul><li>Real and nominal variables </li></ul></ul><ul><ul><li>Price index </li></ul></ul>
  54. 54. Preparing for the Quiz <ul><li>Know the differences between </li></ul><ul><ul><li>Intermediate goods vs Capital goods </li></ul></ul><ul><ul><li>GDP vs GNP </li></ul></ul><ul><ul><li>GDP deflator vs Consumer Price Index </li></ul></ul><ul><li>Know how to compute </li></ul><ul><ul><li>Nominal GDP </li></ul></ul><ul><ul><li>Real GDP </li></ul></ul><ul><ul><li>GDP deflator </li></ul></ul><ul><ul><li>% Changes in these variables </li></ul></ul>
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