CHAPTER TWO

macro The Data of

Macroeconomics

macroeconomics
fifth edition

N. Gregory Mankiw
PowerPoint® Slides
by Ron Cronovich

© 2002 Worth Publishers, all rights reserved

 Learning objectives
In this chapter, you will learn
about:
 Gross Domestic Product (GDP)
 the Consumer Price Index (CPI)
 the Unemployment Rate

CHAPTER 2 The Data of Macroeconomics slide 2

 Gross Domestic Product

Two definitions:
1. Total expenditure on
domestically-produced
final goods and services
2. Total income earned by
domestically-located
factors of production

CHAPTER 2 The Data of Macroeconomics slide 3

 Why expenditure = income

In
Inevery
everytransaction,
transaction,
the
thebuyer’s
buyer’sexpenditure
expenditure
becomes
becomesthe theseller’s
seller’sincome.
income.
Thus,
Thus,the
thesum
sumof ofall
all
expenditure
expenditureequals
equals
the
thesum
sumof ofall
allincome.
income.

CHAPTER 2 The Data of Macroeconomics slide 4

 The Circular Flow
Income
($)

Labor

Households Firms

Goods
(bread
)

Expenditure
($)

CHAPTER 2 The Data of Macroeconomics slide 5

 Value added
definition:
A firm’s value added is
the value of its output
minus
the value of the intermediate goods

the firm used to produce that

output.

CHAPTER 2 The Data of Macroeconomics slide 6

 Exercise: (Problem 2, p.38)
 A farmer grows a bushel of wheat
and sells it to a miller for $1.00.
 The miller turns the wheat into flour
and sells it to a baker for $3.00.
 The baker uses the flour to make a loaf of
bread and sells it to an engineer for $6.00.
 The engineer eats the bread.
Compute
– value added at each stage of production
– GDP

CHAPTER 2 The Data of Macroeconomics slide 7

Final goods, value added, and GDP
 GDP = value of final goods produced
= sum of value added at all
stages of production
 The value of the final goods already
includes the value of the intermediate
goods,
so including intermediate goods in GDP
would be double-counting.

CHAPTER 2 The Data of Macroeconomics slide 8

The expenditure components of GDP
• consumption
• investment
• government spending
• net exports

CHAPTER 2 The Data of Macroeconomics slide 9

 Consumption (C)
def: the value of all • durable goods
goods and services last a long time
ex: cars, home
bought by households.
appliances
Includes:
• non-durable
goods
last a short time
ex: food, clothing
• services
work done for
consumers
ex: dry cleaning,
air travel.
CHAPTER 2 The Data of Macroeconomics slide 10
 U.S. Consumption, 2001

%% of
of
$$billions
billions GDP
GDP
Consumption
Consumption $7,064.5
$7,064.5 69.2%
69.2%
Durables
Durables 858.3
858.3 8.4
8.4
Nondurables
Nondurables 2,055.1
2,055.1 20.1
20.1
Services
Services 4,151.1
4,151.1 40.7
40.7

CHAPTER 2 The Data of Macroeconomics slide 11

 Investment (I)
def1: spending on [the factor of production]
capital.
def2: spending on goods bought for future use.
Includes:
 business fixed investment
spending on plant and equipment that firms
will use to produce other goods & services
 residential fixed investment
spending on housing units by consumers and
landlords
 inventory investment
the change in the value of all firms’ inventories
CHAPTER 2 The Data of Macroeconomics slide 12
 U.S. Investment, 2001

%
% of
of
$$billions
billions GDP
GDP
Investment
Investment $1,633.9
$1,633.9 16.0%
16.0%
Business
Businessfixed
fixed 1,246.0
1,246.0 12.2
12.2
Residential
Residentialfixed
fixed 446.3
446.3 4.4
4.4
Inventory
Inventory -58.4
-58.4 -0.6
-0.6

CHAPTER 2 The Data of Macroeconomics slide 13

 Investment vs. Capital

 Capital is one of the factors of

production.
At any given moment, the economy
has a certain overall stock of capital.
 Investment is spending on new
capital.

CHAPTER 2 The Data of Macroeconomics slide 14

 Investment vs. Capital
Example (assumes no depreciation):
 1/1/2002:
economy has $500b worth of capital
 during 2002:
investment = $37b
 1/1/2003:
economy will have $537b worth of
capital

CHAPTER 2 The Data of Macroeconomics slide 15

Stocks vs. Flows
Flow Stock

More
examples:
stock flow
a person’s wealth a person’s saving
# of people with # of new college
college degrees graduates
the govt. debt the govt. budget deficit
CHAPTER 2 The Data of Macroeconomics slide 16
 Government spending (G)
 G includes all government spending on
goods and services.
 G excludes transfer payments
(e.g. unemployment insurance
payments), because they do not
represent spending on goods and
services.

CHAPTER 2 The Data of Macroeconomics slide 17

 Government spending, 2001
%% of
of
$$billions
billions GDP
GDP
Gov
Govspending
spending $1,839.5
$1,839.5 18.0%
18.0%
Federal
Federal 615.7
615.7 6.0
6.0
Non-defense
Non-defense 216.6
216.6 2.1
2.1
Defense
Defense 399.0
399.0 3.9
3.9
State
State&&local
local 1,223.8
1,223.8 12.0
12.0
CHAPTER 2 The Data of Macroeconomics slide 18
 Net exports (NX = EX - IM)
def: the value of total exports (EX)
minus the value of total imports (IM)
U.S.
U.S.Net
NetExports,
Exports,1960-2000
1960-2000
50
50
00
-50
-50
-100
-100
billions
$$billions

-150
-150
-200
-200
-250
-250
-300
-300
-350
-350
-400
-400
1960
1960 1965
1965 1970
1970 1975
1975 1980
1980 1985
1985 1990
1990 1995
1995 2000
2000
CHAPTER 2 The Data of Macroeconomics slide 19
 An important identity

Y = C + I + G + NX
where
Y = GDP = the value of total output
C + I + G + NX = aggregate expenditure

CHAPTER 2 The Data of Macroeconomics slide 20

 A question for you:
Suppose a firm
 produces $10 million worth of final
goods
 but only sells $9 million worth.

Does this violate the

expenditure = output identity?

CHAPTER 2 The Data of Macroeconomics slide 21

 Why output = expenditure
 Unsold output goes into inventory,
and is counted as “inventory
investment”…
…whether the inventory buildup was
intentional or not.
 In effect, we are assuming that
firms purchase their unsold output.

CHAPTER 2 The Data of Macroeconomics slide 22

 GDP:
An important and versatile concept
We have now seen that GDP
measures
 total income
 total output
 total expenditure
 the sum of value-added at all
stages
in the production of final goods

CHAPTER 2 The Data of Macroeconomics slide 23

 GNP vs. GDP
 Gross National Product (GNP):
total income earned by the nation’s factors of
production, regardless of where located
 Gross Domestic Product (GDP):
total income earned by domestically-located
factors of production, regardless of nationality.

(GNP – GDP) = (factor payments from abroad)

– (factor payments to abroad)

CHAPTER 2 The Data of Macroeconomics slide 24

(GNP – GDP) as a percentage of GDP
for selected countries, 1997.
U.S.A. 0.1%
Bangladesh 3.3
Brazil -2.0
Canada -3.2
Chile -8.8
Ireland -16.2
Kuwait 20.8
Mexico -3.2
Saudi Arabia 3.3
Singapore 4.2

CHAPTER 2 The Data of Macroeconomics slide 26

 Real vs. Nominal GDP
 GDP is the value of all final goods
and services produced.
 Nominal GDP measures these
values using current prices.
 Real GDP measure these values
using the prices of a base year.

CHAPTER 2 The Data of Macroeconomics slide 28

Real GDP controls for inflation
Changes in nominal GDP can be due to:
 changes in prices
 changes in quantities of output
produced
Changes in real GDP can only be due to
changes in quantities,
because real GDP is constructed using
constant base-year prices.

CHAPTER 2 The Data of Macroeconomics slide 29

 Practice problem, part 1
2001 2002 2003
P Q P Q P Q
good A $30 900 $31 1,000 $36 1,050

good B $100 192 $102 200 $100 205

 Compute nominal GDP in each year

 Compute real GDP in each year
using 2001 as the base year.

CHAPTER 2 The Data of Macroeconomics slide 30

Answers to practice problem, part 1
 Nominal GDP multiply Ps & Qs from same
year
2001: $46,200 = $30  900 + $100  192
2002: $51,400
2003: $58,300

 Real GDP multiply each year’s Qs by 2001

Ps
2001: $46,300
2002: $50,000
2003: $52,000 = $30  1050 + $100  205
CHAPTER 2 The Data of Macroeconomics slide 31
 U.S. Real & Nominal GDP, 1967-2001
11,000
11,000
10,000
10,000
9,000
9,000
dollars)
U.S.dollars)

8,000
8,000
7,000
7,000
6,000
6,000
(billionsofofU.S.

5,000
5,000
4,000
4,000
(billions

3,000
3,000
2,000
2,000
1,000
1,000
00
1965
1965 1970
1970 1975 1975 1980 1980 1985
1985 1990 1990 1995
1995 2000
2000
NGDP
NGDP(billions
(billionsofof$)$) RGDP
RGDP(billions
(billionsofof1996
1996$)$)

CHAPTER 2 The Data of Macroeconomics slide 32

 GDP Deflator
 The inflation rate is the percentage
increase in the overall level of prices.
 One measure of the price level is
the GDP Deflator, defined as

Nominal GDP
GDP deflator = 100 
Real GDP

CHAPTER 2 The Data of Macroeconomics slide 33

 Practice problem, part 2
Nom. GDP inflation
Real GDP
GDP deflator rate
2001 $46,200 $46,200 n.a.

2002 51,400 50,000

2003 58,300 52,000

 Use your previous answers to compute
the GDP deflator in each year.
 Use GDP deflator to compute the inflation rate
from 2001 to 2002, and from 2002 to 2003.

CHAPTER 2 The Data of Macroeconomics slide 34

 Answers to practice problem, part 2
Nom. GDP inflation
Real GDP
GDP deflator rate
2001 $46,200 $46,200 100.0 n.a.

2002 51,400 50,000 102.8 2.8%

2003 58,300 52,000 112.1 9.1%

CHAPTER 2 The Data of Macroeconomics slide 35

Working with percentage changes
USEFUL
USEFUL TRICK
TRICK #1
#1 For
For any
any variables
variables XX
and
and YY,,
the
thepercentage
percentagechange
changein
in ((XX 
YY))
 the
 thepercentage
percentagechange
changein in XX
++ the
thepercentage
percentagechange
changein in YY
EX: If your hourly wage rises 5%
and you work 7% more hours,
then your wage income rises approximately 12%.

CHAPTER 2 The Data of Macroeconomics slide 38

Working with percentage changes
USEFUL
USEFUL TRICK
TRICK #2
#2
the
thepercentage
percentagechange
changeinin ((XX//YY))
 the
 thepercentage
percentagechange
changein in XX
 the
thepercentage
percentagechange
changein in YY

EX: GDP deflator = 100  NGDP/RGDP.

If NGDP rises 9% and RGDP rises 4%,
then the inflation rate is approximately 5%.

CHAPTER 2 The Data of Macroeconomics slide 39

 Chain-weighted Real GDP
 Over time, relative prices change, so the
base year should be updated periodically.
 In essence, “chain-weighted Real GDP”
updates the base year every year.
 This makes chain-weighted GDP more
accurate than constant-price GDP.
 But the two measures are highly correlated,
and constant-price real GDP is easier to
compute…
 …so we’ll usually use constant-price real
GDP.
CHAPTER 2 The Data of Macroeconomics slide 40
 Consumer Price Index (CPI)
 A measure of the overall level of prices
 Published by the Bureau of Labor
Statistics (BLS)
 Used to
– track changes in the
typical household’s cost of living
– adjust many contracts for inflation
(i.e. “COLAs”)
– allow comparisons of dollar figures
from different years

CHAPTER 2 The Data of Macroeconomics slide 41

How the BLS constructs the CPI
1. Survey consumers to determine
composition of the typical consumer’s
“basket” of goods.
2. Every month, collect data on prices of all
items in the basket; compute cost of basket
3. CPI in any month equals
Cost of basket in that month
100 
Cost of basket in base period

CHAPTER 2 The Data of Macroeconomics slide 42

 Exercise: Compute the CPI

The basket contains 20 pizzas and

10 compact discs.

prices: For each year,

pizza CDs compute
2000 $10 $15  the cost of the
2001 $11 $15 basket
 the CPI (use 2000
2002 $12 $16
as the base year)
2003 $13 $15
 the inflation rate
from the preceding
CHAPTER 2 The Data of Macroeconomics
year slide 43
 answers:

cost of inflation
basket CPI rate
2000 $350 100.0 n.a.
2001 370 105.7 5.7%
2002 400 114.3 8.1%
2003 410 117.1 2.5%

CHAPTER 2 The Data of Macroeconomics slide 44

The composition of the CPI’s “basket”
Food and bev.
5.8% 5.9%
Housing 17.6%
2.8%
Apparel 2.5%
4.5% 4.8%
Transportation

Medical care

Recreation
16.2%
Education

Communication
40.0%
Other goods and
services

CHAPTER 2 The Data of Macroeconomics slide 45

 Reasons why
the CPI may overstate inflation
 Substitution bias: The CPI uses fixed weights,
so it cannot reflect consumers’ ability to substitute
toward goods whose relative prices have fallen.
 Introduction of new goods: The introduction
of new goods makes consumers better off and, in
effect, increases the real value of the dollar. But it
does not reduce the CPI, because the CPI uses
fixed weights.
 Unmeasured changes in quality:
Quality improvements increase the value of the
dollar, but are often not fully measured.

CHAPTER 2 The Data of Macroeconomics slide 48

 The CPI’s bias
 The Boskin Panel’s “best estimate”:
The CPI overstates the true increase in
the cost of living by 1.1% per year.
 Result: the BLS has refined the way it
calculates the CPI to reduce the bias.
 It is now believed that the CPI’s bias is
slightly less than 1% per year.

CHAPTER 2 The Data of Macroeconomics slide 49

 CPI vs. GDP deflator
prices of capital goods
• included in GDP deflator (if produced
domestically)
• excluded from CPI
prices of imported consumer goods
• included in CPI
• excluded from GDP deflator
the basket of goods
• CPI: fixed
• GDP deflator: changes every year
CHAPTER 2 The Data of Macroeconomics slide 51
 Two measures of inflation
Percentage
change 16

14 CPI
12

10

6
GDP deflator
4

-2
1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998
Year

CHAPTER 2 The Data of Macroeconomics slide 52

 Categories of the population
 employed
working at a paid job
 unemployed
not employed but looking for a job
 labor force
the amount of labor available for
producing goods and services; all
employed plus unemployed persons
 not in the labor force
not employed, not looking for work.

CHAPTER 2 The Data of Macroeconomics slide 53

Two important labor force concepts
 unemployment rate
percentage of the labor force that
is unemployed
 labor force participation rate
the fraction of the adult population
that ‘participates’ in the labor force

CHAPTER 2 The Data of Macroeconomics slide 54

Exercise: Compute labor force statistics

U.S. adult population by group, April

2002
Number employed = 134.0 million
Number unemployed = 8.6 million
Adult population = 213.5 million
Use the above data to calculate
• the labor force
• the number of people not in the labor force
• the labor force participation rate
• the unemployment rate

CHAPTER 2 The Data of Macroeconomics slide 55

 Answers:
 data: E = 134.0, U = 8.6, POP = 213.5
 labor force
L = E +U = 134.0 + 8.6 = 142.6
 not in labor force
NILF = POP – L = 213.5 – 142.6 = 70.9
 unemployment rate
U/L = 8.6/142.6 = 0.06 or 6.0%
 labor force participation rate
L/POP = 142.6/213.5 = 0.668 or 68.8%

CHAPTER 2 The Data of Macroeconomics slide 56

 Okun’s Law
 Employed workers help produce GDP,
while unemployed workers do not.
So one would expect
a negative relationship between
unemployment and real GDP.
 This relationship is clear in the data…

CHAPTER 2 The Data of Macroeconomics slide 58

 Okun’s Law Okun’s
Okun’sLaw Law states
states
that
that aaone-percent
one-percent
Percentage change decrease
decreasein in
in real GDP
10 unemployment
unemployment isis
associated
associatedwith
withtwo
two
8
1951 percentage
percentagepoints
points
6 1984
of
of additional
additionalgrowth
growth
2000
4 in
inreal
realGDP
GDP
1999

2 1993
1975
0

-2 1982

-3 -2 -1 0 1 2 3 4
Change in
unemployment rate
CHAPTER 2 The Data of Macroeconomics slide 59
 Chapter Summary
1. Gross Domestic Product (GDP) measures
both total income and total expenditure on
the economy’s output of goods & services.

2. Nominal GDP values output at current

prices; real GDP values output at constant
prices. Changes in output affect both
measures, but changes in prices only affect
nominal GDP.

3. GDP is the sum of consumption,

investment, government purchases, and
net exports.
CHAPTER 2 The Data of Macroeconomics slide 60
 Chapter Summary
4. The overall level of prices can be
measured by either
 the Consumer Price Index (CPI),
the price of a fixed basket of goods
purchased by the typical consumer
 the GDP deflator,
the ratio of nominal to real GDP
5. The unemployment rate is the fraction of
the labor force that is not employed.
When unemployment rises, the growth
rate of real GDP falls.
CHAPTER 2 The Data of Macroeconomics slide 61
CHAPTER 2 The Data of Macroeconomics slide 62