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Frank & BernankeFrank & Bernanke33rdrd edition, 2007 edition, 2007
Ch. 5: Ch. 5: Measuring Economic Activity: GDP and Unemployment
22
Why Measure A Nation’s Why Measure A Nation’s IncomeIncome
To have a sense of an economy’s size.To have a sense of an economy’s size. The well being of a citizen, on average, The well being of a citizen, on average,
depends on the nation’s income and its depends on the nation’s income and its population.population.
As the income of the society increases, the As the income of the society increases, the average person will have a higher standard average person will have a higher standard of living.of living.One can drown in a lake of 3-ft average depth.One can drown in a lake of 3-ft average depth.Standard of living may not necessarily be the Standard of living may not necessarily be the
goods and services a household can consume.goods and services a household can consume.
33
Definition of GDPDefinition of GDP
Gross Domestic Product is the market value Gross Domestic Product is the market value of all the final goods and services produced of all the final goods and services produced within a country in a year.within a country in a year. How do you determine the value of child care?How do you determine the value of child care? How do you include the production of steel or How do you include the production of steel or
plastics?plastics? How do you include the sales of existing homes?How do you include the sales of existing homes? How do you account for $4 million paid at an How do you account for $4 million paid at an
auction for a Van Gogh painting?auction for a Van Gogh painting? How do you account for government services?How do you account for government services?
44
Market ValueMarket Value Suppose we live in an economy where only Suppose we live in an economy where only
hamburgers, colas and cookies are hamburgers, colas and cookies are produced.produced.
Prices are: hamburgers $2; colas $1; Prices are: hamburgers $2; colas $1; cookies $0.50.cookies $0.50.
If this economy produces 100 hamburgers, If this economy produces 100 hamburgers, 150 colas and 200 cookies, what is the 150 colas and 200 cookies, what is the market value?market value?
What is the market value if 200 What is the market value if 200 hamburgers, 100 colas and 100 cookies hamburgers, 100 colas and 100 cookies are produced?are produced?
55
Percentages of American Men and Women Percentages of American Men and Women over Age 16 Working Outside the Homeover Age 16 Working Outside the Home
• Increase in female labor force participation increases the demand for housekeeping and child care.
• Unpaid household work is not counted in GDP.• Paid household work is counted in GDP.• The increase in female labor force participation has overstated GDP growth.
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Gross Domestic Product: Gross Domestic Product: Measuring the Nation’s OutputMeasuring the Nation’s Output
Economic NaturalistEconomic NaturalistWhy has female participation in the labor Why has female participation in the labor
market increased by so much?market increased by so much?What explains the trends illustrated in the What explains the trends illustrated in the
previous figure?previous figure?Hint: The concept of comparative advantageHint: The concept of comparative advantage
77
Why GDP Is Equal to Income?Why GDP Is Equal to Income?
How is my contribution to the US economy How is my contribution to the US economy calculated?calculated?The amount of educational service I create is The amount of educational service I create is
equal to my gross income.equal to my gross income.How is the income of a real estate agent How is the income of a real estate agent
calculated?calculated?When she sells a 25-yr old house, she gets a When she sells a 25-yr old house, she gets a
percent of the price as a payment for her percent of the price as a payment for her services.services.
88
Why GDP Is Equal to Income?Why GDP Is Equal to Income?How is the GDP contribution of the How is the GDP contribution of the
textbook company calculated?textbook company calculated?After they pay the author, the paper company After they pay the author, the paper company
and the ink company, the amount of revenue and the ink company, the amount of revenue they get from textbook sales plus the value of they get from textbook sales plus the value of their book inventory (unsold books) is their book inventory (unsold books) is theirtheir contribution to the US GDP.contribution to the US GDP.
Their contribution is equal to wages, salaries, Their contribution is equal to wages, salaries, rent, interest and profits they pay.rent, interest and profits they pay.
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Value AddedValue Added
Calculate the contribution of the Calculate the contribution of the following activities to GDP.following activities to GDP.
Farmer sells cotton for $100.Farmer sells cotton for $100.Cotton is processed into thread and sold Cotton is processed into thread and sold
for $130.for $130.Thread is made into cloth and sold for Thread is made into cloth and sold for
$200.$200.Cloth is made into shirts and sold for Cloth is made into shirts and sold for
$300.$300.
1010
Circular FlowCircular Flow
HouseholdsFirms
Consumption expenditures of households
Income (wages, salaries, rent, interest, profit) earned by households
1111
Circular FlowCircular Flow
Upper flow is equal to GDP.Upper flow is equal to GDP.Lower flow is equal to income.Lower flow is equal to income. If GDP < Income, businesses will If GDP < Income, businesses will
reduce production and create less reduce production and create less income.income.
If GDP > Income, businesses will want If GDP > Income, businesses will want to expand production and create more to expand production and create more income.income.
1212
1313
How Can We Measure GDP?How Can We Measure GDP?
Expenditure Approach: the upper flow.Expenditure Approach: the upper flow.
Y = C + I + G + NXY = C + I + G + NX Income Approach: the lower flow.Income Approach: the lower flow.
Y = Sum of factor incomesY = Sum of factor incomes
Y = Wages + Salaries + Rent + Interest + Y = Wages + Salaries + Rent + Interest + Profits Profits
1414
Components of Expenditure Components of Expenditure ApproachApproach
Consumption Consumption includes spending on includes spending on food, entertainment, shelter, health food, entertainment, shelter, health care, transportation, clothing, household care, transportation, clothing, household items, insurance, education.items, insurance, education.
1515
Components of Expenditure Components of Expenditure ApproachApproach
InvestmentInvestment includes purchases made by includes purchases made by firms to generate future income. firms to generate future income. Machinery, tools, buildings, trucks and Machinery, tools, buildings, trucks and cars are part of investment if they are cars are part of investment if they are bought to generate future income. By bought to generate future income. By convention, newly built houses and convention, newly built houses and inventory are included under investment.inventory are included under investment.
1616
Components of Expenditure Components of Expenditure ApproachApproach
Government purchasesGovernment purchases are expenditures are expenditures of federal, state and local governments on of federal, state and local governments on goods and services plus their payrolls.goods and services plus their payrolls.
1717
Components of Expenditure Components of Expenditure ApproachApproach
Net exports Net exports is exports minus imports.is exports minus imports.Dell Computer sales in China are part of Dell Computer sales in China are part of
US exports.US exports.Dell Computer purchases of plastic molds Dell Computer purchases of plastic molds
for their computers from China are part of for their computers from China are part of US imports.US imports.
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GDPGDP
http://www.bea.gov/bea/dn/nipaweb/TableView.asp#Mid
1919
Labor and Capital Income
Source: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=economic_indicators&docid=05de01.txt
2020
The Three Faces of GDPThe Three Faces of GDP
= =
Market Market value of value of
final final goods goods
and and servicesservices
Production Expenditure Income
InvestmentInvestment
ConsumptionConsumption
GovernmentGovernment
purchasespurchases
Net exportsNet exports
Capital Capital IncomeIncome
Labor IncomeLabor Income
= =
2121
A GDP Increase Always Increases A GDP Increase Always Increases The Size of the EconomyThe Size of the Economy
WRONG!WRONG!What if GDP in 2005 were 1000, in 2006 What if GDP in 2005 were 1000, in 2006
were 1500 but inflation was 50%?were 1500 but inflation was 50%? In this case, the increase in GDP is solely In this case, the increase in GDP is solely
attributable to price increases, not attributable to price increases, not improving the well being (standard of improving the well being (standard of living) of the average citizen.living) of the average citizen.
2222
Nominal vs. Real MeasuresNominal vs. Real Measures In macroeconomics, most variables are In macroeconomics, most variables are
measured in real terms, not nominal terms.measured in real terms, not nominal terms.Real variable eliminates the effect of Real variable eliminates the effect of
inflation.inflation.Nominal variable includes the effect of Nominal variable includes the effect of
inflation.inflation.GDP comparisons are always made with GDP comparisons are always made with
real GDP.real GDP.Nominal GDP uses current prices.Nominal GDP uses current prices.Real GDP uses base year prices. Real GDP uses base year prices.
2323
Real and Nominal GDPReal and Nominal GDP
The Economy Produces 2 Goods: Pizza and Soda
Year Pp Qp Ps Qs Nominal GDP Real GDP GDP Deflator
1997 10 1000 2 5000 $20,000.00 $20,000.00 100.01998 11 1000 3 6000 $29,000.00 $22,000.00 131.81999 13 1200 4 7000 $43,600.00 $26,000.00 167.7
Nominal GDP is calculated by adding the amounts spent on eachProduct. Real GDP is calculated by using the prices of pizza and Soda from 1997 o calculate the amounts spent in future years.GDP Deflator is Nominal GDP/Real GDP.
2424
Real and Nominal GDP
2525
What Is Wrong With Real GDP?What Is Wrong With Real GDP?
Real GDP increases if you sell your services Real GDP increases if you sell your services rather than provide them free.rather than provide them free.
If you build a house through Habitat for If you build a house through Habitat for Humanity your work doesn’t count as part of Humanity your work doesn’t count as part of GDP. If you get paid for the same work, it GDP. If you get paid for the same work, it counts.counts.
If you pollute during production and someone If you pollute during production and someone pays to clean the environment, the GDP will pays to clean the environment, the GDP will be higher than if the producer tried to reduce be higher than if the producer tried to reduce pollution during production so no clean-up pollution during production so no clean-up was necessary.was necessary.
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Underground EconomyUnderground Economy
If market transactions cannot be tracked If market transactions cannot be tracked by data collectors, they may be ignored.by data collectors, they may be ignored.
Transactions with high cash usage and Transactions with high cash usage and no paper trail can remain hidden from no paper trail can remain hidden from the government.the government.
GDP may actually be much higher than GDP may actually be much higher than government statistics if there is a large government statistics if there is a large underground economy.underground economy.
2727
Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being
Leisure TimeLeisure TimeShorter work weekShorter work weekStart working laterStart working laterRetire earlierRetire earlier
2828
Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being
Nonmarket Economic ActivitiesNonmarket Economic ActivitiesHousehold productionHousehold productionVolunteer servicesVolunteer servicesNonmarket activities are more important in Nonmarket activities are more important in
poor countriespoor countriesUnderground economyUnderground economy
2929
Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being
Environmental Quality and Resource Environmental Quality and Resource DepletionDepletionBenefits of environment quality are not Benefits of environment quality are not
measured.measured.GDP is not adjusted for resource depletion.GDP is not adjusted for resource depletion.
3030
Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being
Quality of LifeQuality of LifeCrime ratesCrime ratesTraffic congestionTraffic congestionCivic organizationsCivic organizationsOpen spaceOpen space
3131
Real GDP is not the Same Real GDP is not the Same as Economic Well-Beingas Economic Well-Being
Poverty and Economic InequalityPoverty and Economic InequalityGDP does not capture the effects of income GDP does not capture the effects of income
inequalityinequality
3232
GDP & Basic Indicators of Well-BeingGDP & Basic Indicators of Well-Being
IndicatorAll developing
countries
GDP per person 3,530 1,170 25,860(U.S. dollars)
Life expectancy at 64.5 51.7 78.0birth (years)
Infant mortality rate 61 100 6(per 1,000 live births)
Under-5 mortality rate 89 159 6(per 1,000 live births)
Doctors 78 30 252(per 100,000 people)
Incidence of HIV/Aids 1.3 4.3 0.3(% in 15-49 age group)
Undernourished 18 38 Negligiblepeople (%)
Primary enrollment 85.7 60.4 99.9rate (as % of age group)
Secondary enrollment 60.4 31.2 96.2rate (as % of age group)
Adult literacy rate (%) 72.9 51.7 98.6
Least developed countries
Industrialized countries
3333http://hdr.undp.org/hdr2006/statistics/
3434
How Does the Government Measure Unemployment?
• Bureau of Labor Statistics (Department of Labor) collects information every month.
• The first Friday of every month at 8:30 AM eastern time, the unemployment rate for the previous month is announced.
• People of age 16 and older are classified as either EMPLOYED or UNEMPLOYED or NOT IN THE LABOR FORCE.
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How Does the Government Measure Unemployment?
• Employed– Any one working for pay.– It may be full-time or part-time.
• Unemployed– Temporary lay-off.– Waiting to start a job.– Looking for a job.
• Not in the labor force– Retirees– Students– Homemakers– Inmates
3636
The Unemployment RateThe Unemployment Rate
Measuring UnemploymentMeasuring UnemploymentLabor force = employed + unemployedLabor force = employed + unemployed
force labor
unemployed rate ntUnemployme
over and 16 population
force labor rate ionParticipat
3737
U.S. Employment Data, U.S. Employment Data, July 2002 (in millions)July 2002 (in millions)
Employed 134.04
Plus:
Unemployed 8.35
Equals: Labor force 142.39
Plus:
Not in labor force 71.63
Equals:
Working-age (over 16) population 214.02
Unemployment rate = unemployed/labor force = 8.35/142.39 = 5.9%
Participation rate = labor force/working-age population = 142.39/214.02 = 66.5%
3838
http://stats.bls.gov/news.release/empsit.nr0.htm
3939
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet
4040
The Unemployment RateThe Unemployment Rate
The Cost of UnemploymentThe Cost of UnemploymentEconomicEconomicPsychologicalPsychologicalSocialSocial
4141
The Unemployment RateThe Unemployment Rate
The Duration of UnemploymentThe Duration of UnemploymentThe impact of unemployment is influenced by The impact of unemployment is influenced by
how long individuals have been unemployed.how long individuals have been unemployed.The unemployment spellThe unemployment spellThe duration of unemploymentThe duration of unemploymentLong-term unemployedLong-term unemployedChronically unemployedChronically unemployed
4242
The Unemployment RateThe Unemployment Rate
Unemployment SpellUnemployment SpellA period during which an individual is A period during which an individual is
continuously unemployedcontinuously unemployedDurationDuration
The length of an unemployment spellThe length of an unemployment spell
4343
The Unemployment RateThe Unemployment Rate
The Duration of UnemploymentThe Duration of UnemploymentDiscouraged workersDiscouraged workers Involuntary part-time workersInvoluntary part-time workers In July 2002:In July 2002:
Official unemployment rate = 5.9%Official unemployment rate = 5.9%Including discouraged workers and involuntary Including discouraged workers and involuntary
part-time worker = 9.4%part-time worker = 9.4%
4444
The Unemployment RateThe Unemployment Rate
Discouraged WorkersDiscouraged WorkersPeople who say they would like to have a job People who say they would like to have a job
but have not made an effort to find one in the but have not made an effort to find one in the last four weekslast four weeks