Lecture 2: National Income Accounting

L11200 Introduction to Macroeconomics 2009/10

Reading: Barro Ch.228 January 2010

Introduction

• Last time: introduction to the course– Textbook: Barro, R.J. ‘Macroeconomics: A Modern

Approach (International Edition)– 2 central topics in the course: economic growth

and economic fluctuations

• This lecture: national income accounting– Defining and explaining basic terminology and

measurement for macroeconomics– GDP, unemployment, inflation etc..

1. Gross Domestic Product (GDP)

• An economy is composed of:• Non-productive wealth:– Houses, parks, cds, furniture, ipods, paintings.

• Productive assets: (the factors of production)– Capital: machines, factories, computers– Labour: workers (including their skills)

• If we added up the value of all this, we could measure ‘the total value of the U.K.’

GDP Basics

• Non-productive wealth doesn’t make anything• Productive assets can be used to make:– More productive assets (e.g making new

machines). We call this investment.– Goods and services for consumption. • Durables, which add to wealth (e.g. furniture)• Non-durables, which are one-off consumption (e.g. ice-

creams, hair cuts)– The total value of goods + services + investment is

known as Gross Domestic Product (GDP).

GDP Basics

• So GDP is a flow variable: a stream of output. – i.e. if the economy froze for 1 year, total wealth

would be unchanged, but GDP would be 0.

• GDP growth is the change in GDP between the last period and this one.

• So GDP growth can be positive or negative (at the moment it is negative).

Real GDP• GDP is measured in £s (nominal GDP). • Figures have to be adjusted to take account

of inflation (real GDP)

Real GDP

• So can calculate ‘GDP at constant prices’– But prices change over time to reflect changing

value of production, not just inflation– e.g. computers have fallen in cost over time, so

using 1995 prices would overstate true price– Instead use average prices over consecutive years – This is know as chain-weighted real GDP, see

example in Barro Ch.2

Measuring GDP

• Three ways to measure GDP– Total expenditure = personal consumption + gross

private domestic investment + government purchases + (exports – imports)

– Total income = value added by all stages in production process

– Total production = total value of all output produced in the economy

– All 3 measures should be identical

2. Employment and Unemployment

• Every person is either– Out of the labour force: doesn’t want a job

e.g. retired, sick, looking after children– In the labour force: wants a job• Of which some are employed (have a job)• Or unemployed (do not have a job)

• The term ‘working age population’ refers to everyone aged 16-65 (men) 16-60 (women)– i.e. above school age and before retirement age

3. Prices and Inflation

• The aggregate price level is calculated by:– Recording the price of goods and services– Weighting goods and services by how much

consumers purchase (using a survey)– Calculating a weighted average using the above

• The change in the price level is the inflation rate– 2% inflation rate means prices are, on average, 2%

higher this year than last year

4. Interest Rates

• The price of money is given by an interest rate– The price applies for a time period (how long you

want to borrow the money for

• Historically, influencing interest rates in the economy has been a policy tool– Changes to the price of money impact on

borrowing / saving, and so influence demand– The key interest rat is the bank of England repo

rate (‘base rate’) which affects all other rates.

Summary

• Key variables in macroeconomics: GDP, unemployment, inflation, interest rates

• More detail on calculation and measurement in Barro Ch.2

• Next time: begin first major section of course on economic growth