econ 2 lecture 2

1. Lecture 2
Principles of Macroeconomics
Measurement
Spring, 2009

2. Question
• I have been able to log on to the
GauchoSpace site.
• A) TRUE
• B) FALSE

3. Question
• I am receiving emails that you sent
through the GauchoSpace site.
• A) TRUE
• B) FALSE

4. Aplia
• I have been able to use Aplia
• A) Yes
• B) No
• C) Have not yet tried

5. Iclicker
• If you have already used the Iclicker
to answer questions go to:
• www.iclicker.com/registration
• And follow the instructions

6. Iclicker
• Points:
• 1 point for showing up and answering
questions
• 1 point for each right answer

7. Grading
• Iclicker: 10%
• HW: 20%
• Midterm: 30%
• Final: 40%
• Grade distribution:
• 10% of class A- and above
• 40% of class B- and above

8. Tracking the Economy
• Very interesting time to be studying
Macro
• Bernanke is fairly new
• Credit market turmoil
• Economy is in a recession

9. Tracking the Economy
• Analysts look at lots of data to see
where the economy is and where it
may be heading.

10. Tracking the Economy

11. Tracking the Economy
• The unemployment rate as of
February, 2009 was:
• A) 8.1%
• B) 9.0%
• C) 7.3%
• D) 6.8%
• E) 6.2%

12. Tracking the Economy
• The unemployment rate as of
February, 2009 was:
• A) 8.1

13. Tracking the Economy

14. Tracking the Economy

15. Tracking the Economy

16. Tracking the Economy

17. Measurement
• So far, lots of terms
• GDP: Real and Nominal
• Unemployment and Employment
• Economics is built on
• Measurement
• Theory

18. THE GENERALLY AGREED
UPON MEASURE OF ECONOMIC
SUCCESS IS GDP

19. GDP
• Real GDP is currently about:
• A) $100 billion
• B) $900 billion
• C) $ 2 trillion
• D) $ 5 trillion
• E) $12 trillion

20. Trick Question (Sort of)
• What does REAL mean?
• Recall, it means getting rid of
changes in the price level
• i.e., removing inflation
• So, the question should have said:
• What is real GDP measured using a
chained index for the year 2000

21. GDP
• Real GDP is currently about:
• About 300 million persons X
almost $40,000 real per capita
income
• E) about $12 trillion

22. GROSS DOMESTIC PRODUCT
Gross Domestic Product is a
measure of the value of all final
goods and services newly produced
within a specified country’s borders
during a specified period of time
(usually one year or one quarter).

23. GROSS DOMESTIC PRODUCT
Gross Domestic Product is a
measure of the value of all final
goods and services newly produced
within a specified country’s borders
during a specified period of time
(usually one year or one quarter).

24. GROSS DOMESTIC PRODUCT
Gross Domestic Product is a
measure of the value of all final
goods and services newly produced
within a specified country’s borders
during a specified period of time
(usually one year or one quarter).

25. GROSS DOMESTIC PRODUCT
Gross Domestic Product is a
measure of the value of all final
goods and services newly produced
within a specified country’s borders
during a specified period of time
(usually one year or one quarter).

26. GROSS DOMESTIC PRODUCT
Gross Domestic Product is a
measure of the value of all final
goods and services newly produced
within a specified country’s borders
during a specified period of time
(usually one year or one quarter).

27. GROSS DOMESTIC PRODUCT
Gross Domestic Product is a
measure of the value of all final
goods and services newly produced
within a specified country’s borders
during a specified period of time
(usually one year or one quarter).

28. GDP
• Final Goods or Services
• Goods or services consumed by
the ultimate user; because they are
the end products of the production
process, they are counted as part
of GDP

29. GDP
• Intermediate Goods or Services
• Goods or services used up in the
production of final goods and
services and therefore not counted
as part of GDP

30. Capital Goods
• Example: A good that can be either
intermediate or final:
• Capital Good
• A long-lived good, which is itself
produced and used to produce
other goods and services

31. Capital Goods
• Example: A good that can be either
intermediate or final:
• Capital Good
• Newly produced capital goods
are classified as final goods.

32. Capital Goods
• Example:
• Factories, tractors, houses
• Note:
• They are not consumed by the
final user, but are not used up in
the production process either

33. LET’S PLAY “GDP or NOT”!
I visit Disneyland …..……………….………….
I buy a used car…………………………………
A tire company makes tires for an auto
company .………………………………………..
I wash my car at a car wash …………….……
A cow stands in a field and gets fat…….…...
I live in a home I bought years ago…….…...
GDP!
NOT!
NOT!
GDP!
GDP!
GDP!

34. Problems with GDP
• We want to keep it real

35. Real GDP needs to be distinguished
from nominal, or current-dollar
GDP, which is output in a given
year measured at the prices
prevailing in that year.
(We’ll return to this point a little
later.)

36. Problems with GDP
• We want to keep it real
• Population matters

37. 0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000
45,000
50,000
1929 1939 1949 1959 1969 1979 1989 1999
(2000 Dollars, chained)
Sources: Bureau of Economic Analysis, Bureau of the Census
PER CAPITA REAL GDP, US

38. 2000 Dollars
Source: Penn World Tables, Version 6.2
PER CAPITA REAL GDP, SELECTED COUNTRIES
Saudi Arabia
Ethiopia
China
Mexico
Ireland
Singapore
Japan

39. Problems with GDP
• We want to keep it real
• Population matters
• Non-market activities

40. 0 5 10 15 20 25 30
Greece
Italy
Spain
Portugal
Belgium
Sweden
Germany
France
Holland
United Kingdom
Japan
United States
Switzerland
The Underground Economy as a Percent of GDP
Source: The Journal of Economic Literature, 2000

41. Problems with GDP
• We want to keep it real
• Population matters
• Non-market activities
• Leisure

42. Figure 4: “Total Work”
-12
-10
-8
-6
-4
-2
0
1965 1975 1985 1993 2003
Hours
Per
Week
All Males Females
Source: Aguiar and Hurst (2005)

43. Figure 5a: Trends in Leisure (All)
0
2
4
6
8
10
1965 1975 1985 1993 2003
Hours
Per
Week
Leisure Measure 1 Leisure Measure 2 Leisure Measure 3
Source: Aguiar and Hurst (2005)

44. Problems with GDP
• We want to keep it real
• Population matters
• Non-market activities
• Leisure
• Environmental quality

45. “…economists looking for an alternative accounting
framework to supplement the use of GDP are
considering a new measure: green net national
product….”
The "green" means that GDP must be reduced to
take into account the depletion of natural resources
and the degradation of the environment - just as a
company must depreciate both its tangible and
intangible assets. "Net" national product (NNP)
means that there has to be an adjustment for the
depreciation of the country's physical assets.
Source: “Good numbers gone bad,” Joseph Stiglitz, Fortune
Magazine, September 25, 2006
GREEN GDP

46. CHINA GOES GREEN
"China Green National Accounting Study Report 2004" was
issued jointly to the public by the State Environmental
Protection Administration of China (SEPA) and the National
Bureau of Statistics of China (NBS) on Sept. 08, 2006.
The report, the first of its kind on environmentally-
adjusted GDP accounting in China, and marks the fact that
the initial progress had been achieved on Chinese green
GDP accounting.
Source: Xinhua Online, September 12, 2006:
http://news.xinhuanet.com/english/2006-09/12/content_5080599.htm

47. CHINA GOES GREEN
The preliminary results show that economic
loss caused by environmental pollution
reaches 511.8 billion yuan, accounting for
3.05% of national GDP in 2004 while
imputed treatment cost is 287.4 billion yuan,
accounting for 1.80% of that.
Source: Xinhua Online, September 12, 2006:
http://news.xinhuanet.com/english/2006-09/12/content_5080599.htm

48. China Goes Green
• Soon after that they dropped the
whole idea—it just looked too bad!

49. Problems with GDP
• We want to keep it real
• Population matters
• Non-market activities
• Leisure
• Environmental quality
• What does it mean for overall
welfare?

50. Problems with GDP
• We want to keep it real
• Population matters
• Non-market activities
• Leisure
• Environmental quality
• What does it mean for overall
welfare?
“Yeah, you’re rich, but are you happy?”

51. GDP & Basic Indicators of
Well-Being
Indicator
All developing
countries
GDP per person 4,054 1,307 29,000
(U.S. dollars)
Life expectancy at 64.7 50.7 78.4
birth (years)
Infant mortality rate 61 99 5
(per 1,000 live births)
Under-5 mortality rate 89 157 7
(per 1,000 live births)
Births attended by skilled 55 33 99
health personnel (%)
Prevalence of HIV/Aids 1.2 3.4 0.3
(% in 15-49 age group)
Undernourished people (%) 17 37 Negligible
Combined gross enrollment 60 43 93
rate for prim/sec/tert schools(%)
Adult literacy rate (%) 76.7 52.5 99
Total population in group
of countries (millions) 4,936.9 700.9 911.6
Least developed
countries
Industrialized
countries

52. The Genuine Progress Indicator
“Few would dispute the fact that gross domestic product
(GDP) fails as a true measure of economic welfare…
The [Genuine Progress Indicator uses]… the same
personal consumption data as GDP but make[s]
adjustments for income inequality and costs of crime,
environmental degradation, and loss of leisure and
additions to account for the services from consumer
durables and public infrastructure as well as the benefits of
volunteering and housework.”
Source: “The Genuine Progress Indicator 2006”, Dr. John Talberth,
Clifford Cobb, and Noah Slattery, February 2007

53. The Genuine Progress Indicator:
United States
Source: “The Genuine Progress Indicator 2006”, Dr. John Talberth,
Clifford Cobb, and Noah Slattery, February 2007

54. The Genuine Progress
Indicator
• Relative to standard GDP, the GPI is
consumption based with the following
adjustments:
• adds the value of services of consumer
durables (subtracting out expenditure)
• adds the services of highways and streets
• adds in net investment (as long as its not
financed by foreigners)

55. The Genuine Progress
Indicator
• Relative to standard GDP, the GPI is
consumption based with the
following adjustments:
• consumption is discounted
according to the degree of income
inequality
• Side comment: I might be happier
with less as long as they took even
more away from you???

56. The GPI
• Relative to standard GDP, the GPI is
consumption based with the following
adjustments:
• adds the value of time spent on household
work, parenting, and volunteer work
• subtracts the loss of leisure time (through
more market work and longer commuting
times)
• “The GDP creates the illusion that the nation is
getting richer, when in fact people are working
harder to produce and buy more and pay interest
on mounting personal indebtedness.” [emphasis
added]
• Side comment: Would Aguiar and Hurst agree?

57. The GPI
• Relative to standard GDP, the GPI subtracts:
• The costs of crime: Out of pocket expenditures,
value of stolen property, as well as expenditures
on locks, burglar alarms, security devices and
services.
• The costs of household pollution abatement --
water and air filters – and social costs.
• “This may involve some double counting…”

58. The GPI
• Relative to standard GDP, the GPI
subtracts:
• The costs of crime: Out of pocket
expenditures, value of stolen property, as
well as expenditures on locks, burglar
alarms, security devices and services.
• “Most of us would not otherwise purchase
these… items.”
• Side Comment: Like if we lived in heaven

59. The GPI
• Relative to standard GDP, the GPI subtracts:
• The costs of automobile accidents.
• The costs of noise pollution, loss of wetlands loss
of farmland, loss of primary forests, and depletion
of nonrenewable resources, and other
environmental adjustments.
• Side comment: I would adjust for the loss of chili-
cheese burritos from the Taco Bell menu and add
Celine Dion to the noise pollution adjustment.

60. The GPI
• Relative to standard GDP, the GPI subtracts:
• The costs of underemployment
• Essentially: Not counting unwanted leisure
(whatever that means).
• Side comment: I think I have approximately 30 hours
per week of unwanted leisure – I’d be working those 30
hours if someone paid me $5000 per hour.

61. HOW IS GDP MEASURED?

62. Measuring GDP
• We measure GDP in market “values” from
three “theoretically” identical measures:
1. How much is produced: Product or value-
added approach
2. How much is earned: Income approach
3. How much is purchased: Expenditure
Approach

63. The Three Faces of GDP
= =
Market
Market
value of
value of
final
final
goods
goods
and
and
services
services
Production Expenditure Income
Investment
Investment
Consumption
Consumption
Government
Government
purchases
purchases
Net exports
Net exports
Capital
Capital
Income
Income
Labor Income
Labor Income

64. THE CIRCULAR FLOW
Everything produced is an income
to someone.
Everything produced is paid for (is
an expenditure) by someone.

65. Everything produced, is purchased by
someone…
Total Production = Total Expenditure

66. GDP
• It is part of the National Product and
Income Accounts (NIPA)
• produced by the Bureau of
Economic Analysis (BEA)
• Here is a picture of an actual table:
• www.bea.gov

67. Facts you should know
• Nominal GDP 2006: $13 trillion
• Real GDP 2006 chained (2000)
dollars:
$11.5 trillion
(We will see what chained (2000)
dollars means later)

68. An Artificial Economy
• Corn producer:
• Sells corn for feed to hog farmer
• Sells corn directly to consumers to
eat

69. An Artificial Economy
• Corn producer:
• Sells corn for feed to hog farmer
• Sells corn directly to consumers to
eat
• Note that corn is an intermediate
good and a final consumption good
• Intermediate good: a good that is
produced and then used as input to
another production process

70. An Artificial Economy
• Hog farmer sells hogs to consumers
• Government collects taxes and uses
the tax revenue to hire workers to
build a wooden bridge using lumber
from public land

71. Corn Producer
• Seeds sprout magically from the
ground

72. Corn Producer
• 2006 Production: 10 million bushels
• 6 million to hog farmer and
• 4 million to consumers
• Sold at $2.00 per bushel
• Total revenue: $20 million

73. Corn Producer
$0.5 million
Interest on loan
$5 million
Wages
$1.5 million
Taxes
$20 million
Total Revenue

74. Hog Producer
$12 million
Cost of feed corn
$4 million
Wages
$3 million
Taxes
$30 million
Total Revenue
• 20 million pounds of hogs
• Sold at $1.50 per pound to consumers

75. Artificial Economy
• After-tax profits =
Total Revenue - Wages - Interest -
Cost of intermediate inputs - taxes
$11 million
Hog producer
$13 million
Corn producer
After-tax profits

76. Consumers
$1 million
Pay Taxes
$0.5 million
Interest income
$24 million
Profits
$14.5 million
Wage income

77. Artificial Economy
• Government sector
$5.5 million
Wages
$5.5 million
Tax Revenue

78. GDP: Product (Value-added)
Approach
• Idea:
• sum the value added of goods and
services in production across all
productive units in the economy

79. GDP: Product (Value-added)
Approach
• Idea:
• Sum the value added of goods and
services in production across all
productive units in the economy
• Value-added:
• Add the value of all goods produced in
the economy and then subtract the
value of all intermediate goods
• If we did not subtract off intermediate
goods we would be double-counting

80. GDP: Product (Value-added)
Approach
• What is the value-added for the corn
producer?
• A) 20 million
• B) 15 million
• C) 13 million
• D) 0

81. GDP: Product (Value-added)
Approach
• What is the value-added for the hog
producer?
• A) 30 million
• B) 18 million
• C) 11 million
• D) 0

82. GDP: Product (Value-added)
Approach
• What is the value-added for the
Government?
• A) 11 million
• B) 5.5 million
• C) 0
• D) None of the above, the
government can’t have value
added

83. GDP: Product (Value-added)
Approach
• Value-added for the corn producer:
• $20 million - $0 = $20 million
• Value-added for the hog producer:
• $30 million - $12 million = $18
million
• Value-added for the government:
• $5.5 million - $0 = $5.5 million

84. GDP: Product (Value-added)
Approach
• Value added for the government is a
tricky problem
• When the government built the
bridge it did not sell it at market
prices
• Convention is to value at the
cost of production

85. GDP: Product (Value-added)
Approach
$5.5 million
Value-added: gov’t
$18 million
Value-added: hogs
$43.5 million
GDP
$20 million
Value-added: corn

86. Final Goods
• Note, could have just added the
sales of FINAL GOODS to end-users:
• Corn farmer: $8 million
• Hog farmer: $30 million
• Govt.: : $5.5 million
• Total: $43.5 million

87. End of Lecture 2