Expert answer:the financial markets
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CHAPTER
SLIDES
BY
SOLINA LINDAHL
GDP and the CPI: Tracking
the Macroeconomy
7(22)
FOOD FOR THOUGHT….
SOME GOOD BLOGS AND OTHER SITES TO GET THE JUICES FLOWING:
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What you will
learn in this chapter
▪ How economists use aggregate measures to
track the performance of the economy
▪ What gross domestic product, or GDP, is and
the three ways of calculating it
▪ The difference between real GDP and
nominal GDP and why real GDP is the
appropriate measure of real economic
activity
▪ What a price index is and how it is used to
calculate the inflation rate
To
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To First
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HOW DO YOU MEASURE AN ECONOMY?
2010 headline: “China Passes Japan as SecondLargest Economy.”
How can you compare the sizes of two economies when
they produce different things?
By comparing the value of their production.
GDP (gross domestic product) is the most important and
common way to estimate an economy’s size.
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THE NATIONAL ACCOUNTS
The national income and product accounts
(NIPA)
▪ measure our nation’s economic
performance
▪ compare American income and output to
that of other nations
▪ track the economy’s condition throughout
the business cycle
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THE NATIONAL ACCOUNTS
Consumer spending: household spending on
goods and services
Stock: a share in the ownership of a company
held by a shareholder.
Bond: borrowing in the form of an IOU that pays
interest.
Government transfer: payment by the
government to individuals for which no good or
service is provided in return.
Disposable income: income plus government
transfers minus taxes; available to spend on
consumption and to save.
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AN EXPANDED CIRCULAR-FLOW DIAGRAM
Government borrowing
Government purchases of goods and
services
Government transfers
Taxes
Private savings
Consumer spending
Wages, profit,
interest, rent
Financial markets
Factor
markets
Wages, profit,
interest, rent
GDP
Borrowing
and stock
issues by
firms
Investment spending
Foreign borrowing
and sales of stock
Exports
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Imports
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THE NATIONAL ACCOUNTS
Households don’t spend all of their
disposable income. Some of it is saved in
the financial markets.
Private savings: disposable income minus
consumer spending.
Financial markets: the banking, stock, and
bond markets, which channel private
savings and foreign lending into investment
spending, government borrowing, and
foreign borrowing.
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THE NATIONAL ACCOUNTS
The government spends and borrows for
various reasons.
Government borrowing: the total amount of
funds borrowed by federal, state, and local
governments in the financial markets.
Government purchases of goods and
services: total expenditures on goods and
services by federal, state, and local
governments.
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THE NATIONAL ACCOUNTS
The government spends and borrows for various
reasons.
Government borrowing: the total amount of funds
borrowed by federal, state, and local governments
in the financial markets.
Government purchases of goods and services: total
expenditures on goods and services by federal,
state, and local governments.
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THE NATIONAL ACCOUNTS
Exports: goods and services sold to other
countries.
Imports: goods and services purchased from
other countries.
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THE NATIONAL ACCOUNTS
Inventories: stocks of goods and raw
materials held to facilitate business
operations.
Investment spending: spending on
productive physical capital, such as
machinery and construction of structures,
and on changes to inventories.
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WHAT IS GDP?
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CALCULATING GROSS DOMESTIC
PRODUCT
GDP can be calculated three ways:
1. Add up the total value of all final
goods and services produced
2. Add up all spending on domestically
produced final goods and services.
3. Add up the total factor income earned
by households from firms in the
economy
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SPENDING = INCOME
It doesn’t matter HOW we measure the
production, since one person’s spending is
another’s income.
$10 for a shave? Barber’s income of $10 = customer’s spending of $10.
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CALCULATING GROSS DOMESTIC
PRODUCT
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WHAT IS GDP?
…Produced…
GDP measures production.
Sale of used goods: NOT
included.
The sale of financial assets,
such as stocks and bonds,
are not included.
This building’s
value was
counted when it
was built.
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WHAT IS GDP?
…Within a Country…
Only production that takes place within the
borders of a country is included in GDP.
Examples:
Cars produced in Mexico by American firms:
NOT included in the U.S. GDP.
Cars produced in the U.S. by Japanese firms
ARE included in the U.S. GDP.
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LEARN BY DOING: PRACTICE QUESTION
Are the following included in U.S. GDP? (1) The
price paid by a German tourist when staying at
a New York hotel. (2) The price paid by an
American tourist when staying at a Berlin hotel.
a) Both are included in U.S. GDP.
b) Neither is included in U.S. GDP.
c) Only the price paid by a German tourist
when staying at a New York hotel is
included in U.S. GDP.
d) Only the price paid by an American tourist
when staying at a Berlin hotel is included
U.S. GDP.
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WHAT IS GDP?
…in a year.
GDP is like annual income:
it measures a rate of production during
a given period.
For the current quarter’s GDP data, visit
the U.S. Bureau of Economic Analysis
here.
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GDP: WHAT’S IN AND WHAT’S OUT
Included
▪
Domestically produced final goods and services,
including capital goods, new construction of
structures, and changes to inventories
Not Included
▪
▪
▪
▪
▪
Intermediate goods and services
Inputs
Used goods
Financial assets, such as stocks and bonds
Goods and services produced outside this country
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ECONOMICS
IN ACTION
OUR IMPUTED LIVES
Problem: GDP does not
count the value of services
family members provide
to each other… except for
the estimated value of
housing “services” for
those that own their home
(instead of renting)
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METHOD 1: VALUE ADDED
Value added of a producer is the value of
its sales minus the value of its purchases of
intermediate goods and services.
value
added
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METHOD 2: SPENDING
Final goods and services: goods and services
sold to the final, or end, user.
Intermediate goods and services: goods and
services (bought from one firm by another
firm) that are inputs for production of final
goods and services.
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METHOD 2: SPENDING
Add up all spending on domestically
produced final goods and services.
This results in the equation GDP = C + I + G + X –
IM where
C = consumer spending,
I = investment spending,
G = government purchases of goods and services,
X = sales to foreigners, and
IM = imports (purchases here of foreign goods… or
income that has leaked across national borders).
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VALUE ADDED VS. SPENDING METHOD
Components of GDP (billions of dollars)
$20,000
Value added by government
= 12.1%
$15,000
Government purchases of
goods and services
= 18.6%
Value added by households
= 12.4%
Investment spending
= 15.9%
10,000
Value added by business
= 75.5%
C+I+G
= $16,800
Consumer spending
= 68.4%
5,000
0
Value added by sector
Net exports: the difference between the
value of exports and the value of imports.
-5,000
C
Net exports X – IM = (–3.0%)
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LEARN BY DOING: PRACTICE QUESTION
Suppose country A sells $100 million worth of
goods and services to country B. Country B
sells $50 million worth of goods and services
to country A. These are the only two
countries in macro world. Net exports in
country:
a) B equal −$50 million.
b) A equal $150 million.
c) A equal -$150 million.
d) B equal million.
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LEARN BY DOING: PRACTICE QUESTION
Income spent on imported goods:
a) represents income that has leaked across
national borders.
b) must be subtracted from spending data
to calculate an accurate value for
domestic production.
c) is income that is not spent on
domestically produced goods and
services.
d) Answers (a), (b), and (c) are all correct.
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ECONOMICS
IN ACTION
WHO CREATED THE NATIONAL ACCOUNTS (AND
WHY)?
The national accounts owe their creation to the Great
Depression. The only data available were scattered
statistics (railroad data, etc.)
Simon Kuznets (a young Russian-born economist)
developed a set of national income accounts. The first
version was presented to Congress in 1937.
The push to complete the national accounts came during
World War II, when policy makers were in even more need
of comprehensive measures of the economy’s
performance.
The federal government began issuing estimates of gross
domestic product and gross national product in 1942.
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REAL GDP: A MEASURE OF AGGREGATE
OUTPUT
We need to be able track the quantity of total
output over time.
Real GDP: the total value of the final goods and
services produced in the economy during a given
year, calculated using the prices of a selected
base year.
Nominal GDP: the value of all final goods and
services produced in the economy during a given
year, calculated using the prices current in the
year in which the output is produced.
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REAL VS. NOMINAL GDP
Calculating GDP and real GDP in a simple
economy:
how much would GDP have gone up if prices had not
changed? To answer this question, we need to find the
value of output in year 2 expressed in year 1 prices.
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LEARN BY DOING: PRACTICE QUESTION
Nominal GDP in 2011:
a) is greater than nominal GDP in 2010.
b) is less than nominal GDP in 2012.
c) cannot be calculated until a base year is
specified.
d) Answers (a) and (b) are both correct.
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LEARN BY DOING: PRACTICE QUESTION
Suppose the base year is 2010. Real GDP in 2011
using 2010 as the base year:
a) is greater than nominal GDP in 2011.
b) is less than nominal GDP in 2011.
c) is equal to nominal GDP in 2011.
d) may be greater than, less than, or equal to
nominal GDP in 2011.
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LEARN BY DOING: PRACTICE QUESTION
Using 2011 as the base year, real GDP is greatest in:
a) 2010.
b) 2011.
c) 2012.
d) 2010 and 2012, since real GDP using 2011 as the
base year is the same for these two years.
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REAL-LIFE REAL GDP
Nominal versus real GDP in 2005, 2009 and
2013
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REAL VS. NOMINAL GDP
Except in the base year, real GDP is not the
same as nominal GDP: output valued at
current prices.
Chained dollars: the method of calculating
changes in real GDP using the average
between the growth rate calculated on an
early base year and the growth rate
calculated on a late base year.
GDP per capita: average GDP per person; not
by itself an appropriate policy goal.
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GDP AND THE MEANING OF LIFE
Rich is better.
Money matters less as you grow richer.
Money isn’t everything.
Source: Gallup; World Bank.
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ECONOMICS
IN ACTION
MIRACLE IN VENEZUELA?
No, it’s just suffering from unusually high inflation.
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PRICE INDEXES AND THE
AGGREGATE PRICE LEVEL
Aggregate price level: a measure of the
overall level of prices in the economy.
To measure the aggregate price level,
economists calculate the cost of
purchasing a market basket.
Market basket: a hypothetical set of
consumer purchases of goods and services.
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MARKET BASKETS AND PRICE
INDEXES
Calculating the cost of a market basket
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PRICE INDEXES
Price Index: the cost of purchasing a given
market basket in a given year, where that
cost is normalized so that it is equal to 100 in
the selected base year
Price index in = Cost of market basket in a given year x
100
a given year
Cost of market basket in base year
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LEARN BY DOING: PRACTICE QUESTION
Suppose 2011 is the base year and the market basket
for purposes of constructing a price index consists of
200 oranges, 100 apples, and 100 bananas.
What is the value of the price index in 2011?
a) 1.15
b) 100
c) 165
d) 190
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LEARN BY DOING: PRACTICE QUESTION
What is the value of the price index in 2012,
using 2011 as the base year?
a) 0.97
b) 1
c) 100
d) 103
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INFLATION RATE, CPI, AND OTHER
INDEXES
The Inflation rate: the yearly percentage
change in a price index, typically based
upon consumer price index, or CPI, the
most common measure of the aggregate
price level.
The consumer price index, or CPI, measures
the cost of the market basket of a typical
urban American family
Inflation rate = Price index in year 2 – Price index in year 1 x 100
Price index in year 1
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LEARN BY DOING: PRACTICE QUESTION
What is the rate of inflation between 2011
and 2012 in this economy?
a) 0%
b) 3%
c) 103%
d) 67%, since two of the three prices
increased between 2011 and 2012
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THE CONSUMER PRICE INDEX
The makeup of the consumer price index in
2010
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CONSUMER PRICE INDEX
The annual percentage increases in recent years have
been much smaller than those of the 1970s and early 1980s.
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OTHER PRICE MEASURES
Producer price index (PPI): similar to the CPI
but measures changes in the prices of
goods purchased by producers.
Economists also use the GDP deflator, which
measures the price level by calculating the
ratio of nominal to real GDP.
The GDP deflator for a given year is 100
times the ratio of nominal GDP to real GDP
in that year.
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THE CPI, THE PPI, AND THE GDP
DEFLATOR
The three measures usually move closely together.
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Source:
Bureau of Labor Statistics.
I S H E R S
L
ECONOMICS
IN ACTION
INDEXING TO THE CPI
Many payments like Social Security are tied
(“indexed”) to the CPI
This practice goes back to the Revolutionary war:
to keep soldiers’ pay in line with rising prices,
wages were indexed to the cost of:
68 4/7 lbs beef, 10 lbs of wool and 16 lbs of
leather
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LEARN BY DOING: APPLICATION VIDEO
Does money buy happiness? Can well-being be measured?
Does growth equal progress? These may sound like esoteric
questions, but they are at the heart of efforts to move beyond
GDP to develop more accurate ways of measuring human
development touched on in this video. (3:19 minutes)
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LEARN BY DOING: BUSINESS CASE
GETTING A JUMP ON GDP
Many businesses are eager for
macroeconomic data and can’t wait for
the government’s quarterly data
Two organizations supply monthly GDP
estimates:
• Macroeconomic Advisors (based on raw
government data)
• Institute for Supply Management (based
on its own surveys of business orders)
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