Chapter 2 – Measurement 2/5/2013 1:26:00 PM
Understand how macroeconomic variables are measured.
Chief aim on national income accounting is to obtain a measure of
the total quantity of goods and services produced for the market in
a given country over a period of time.
Gross Domestic Product (GDP) – dollar value of final value of output
produced during a given period of time within the borders of
National Income and Expenditure Accounts (NIEA) – where GDP is
published on a quarterly basis.
Three approaches to measuring GDP
o Product Approach
o Expenditure Approach
o Income Approach
Intermediate Good – good that is produced then used as an input to another
After Tax Profits = total revenue – wages – interest – cost of intermediate
inputs – taxes
“value added approach”
The sum of value added to goods and services in production across
all productive units in the economy.
To calculate: add the value of all goods produced in the economy
and subtract all the intermediate goods used in production = total
If we didn’t subtract intermediate goods we would be double
GDP = good produced – intermediate goods used in production
The Expenditure Approach
Total spending on all final goods and services production in the
economy. TotalExpenditure (GDP) CIGNX
C – consumption expenditure
I – investment expenditure (expenditure on goods that are
produced but not consumed during the period under consideration)
G – government expenditure
NX – net exports (total exports – total imports)
The Income Approach
Add up all incomes received by economic agents contributing to
Incomes include profits made by firms, employee compensation,
corporate profits, net interest, etc. Anything coming into the
Why do they all yield same GDP result?
because the quantity of output, or value, added in the economy is
ultimately sold, thus showing up as expenditure, and what is spent
on all output produced is income, in some form or other, for
someone in the economy.
Let Y be GDP in economy
Y is total aggregate output and also total aggregate income.
* Sometimes referred to as the income-expenditure identity. The quantity on
the left side of the identity is the aggregate income and the right side is the
sum of the components of aggregate expenditure.
Gross National Product (GNP)
At one time was used in Canada as the official measure of
aggregate production. However, measures the value of output produced by domestic
factors of production, whether or not production takes place within
or outside of Canada.
Makes big difference in Canada compared to other countries
because a significant fraction of productive plant and equipment in
Canada is foreign owned.
What does GDP leave out?
GDP per person is invalid because does not take into account how
income is distributed across the individuals in the population.
Also leaves out all non market activity.
Underground economy is not measured. Includes all unreported
Invalid values on products. How much really worth.
Components of Aggregate Expenditure
o Accounts for 55% of GDP
o Is the expenditure on consumer goods and services during
the current period, and the components of consumption are
durable goods, semi durable goods and non durable goods.
o Accounts for 20.3% of GDP
o Is the expenditure on goods that are produced but not
consumed during the current period.
o Two typed:
Fixed – production of capital, such as plant, equipment
Inventory – good hat are essentially put in storage.
o Smaller than consumption because much more variable and
plays a large role in the business cycle.
o Accounts for 1.9% of GDP
o Accounts for 22.7% o Consists of expenditures by federal, provincial or territorial,
and municipal goods and services.
o Mainly of government consumption and government
Nominal and Real GDP and Price Indices
A Price Index – a weighted average of the prices of a set of the goods and
services produced in the economy over a period of time. If the price index
includes prices of all goods and services, then that price index is a measure
of the general price level (the average level of prices across all goods and
Inflation Rate – rate of change in the price level from one period of time to
>> Use to determine if the change in GDP from one period to another is real
Nominal Change – change in GDP that occurred only because the
price level changed.
Real Change – increase in the physical quantity of output.
Step 1: Calculate GDP using Year 1 Prices for BOTH years
a a o o
GDP 1 Q 1 Q1 1 1 GDP 2
a a o o G1
GDP 2 Q 1 Q 2 1 2 GDP
Step 2: Calculate GDP using Year 2 prices for BOTH years
a a o o
GDPP1Q P2Q 1 2 1 GDP 2
a a o o GDP 1
GDPP1Q P2Q 2 2 2
Step 3: Apply to FISCHER INDEX
Step 4: Real GDP in Year 2 = FV x Year 1 Real GDP
GDP Deflator for Year 2 =
*since the base is 100 in the GDP deflator answer this means there is a
___% increase in prices between the two years.
*this is not a real world example. Usually targeted between 1 & 3, targeted
*basically GDP2 in using Year 2 prices divided by answer (Real GDP in
Measures of the Price Level
Implicit GDP Deflator = nominal GDP/real GDP x 100
*is the price level of all new prices of domestically produced final
goods in an economy.
*current GDP/chain GDP
Current Year CPI = (cost of base year quantities at current
prices/cost of base year quantities at base year prices) x 100
*if year 1 is the base year assume that the CPI is 100 (base year
always has CPI of 100) and if the CPI is 172.1 then the percentage
increase in the CPI from year 1 to year to is 72.1%
*a measure of the average change over time in the prices paid by
urban consumers for a market basket of consumer goods and
Problems with measuring real GDP and the price level
The measurement of real GDP and the measurement of price level
are intimately related.
Important problems: o First, If a particular measure of GDP underestimates the
growth of real GDP, the rate of inflation will be overestimated.
Chain fixes this problem. It assumes that when price changes
buyers don’t change their buying habits which is clearly false.
Therefore, goods with higher prices receive a higher
weighting in the CPI than they should.
Savings, Wealth and Capital
Aggregate productive capacity and how aggregate savings adds to
this productive capacity.
Flows vs. Stocks
o Flow – rate per unit time
o Stock – the quantity in existence of some object at a point in
o GDP, C, I, G, NX are all flows.
o To help: bathtub. Water flowing into bathtub. The quantity of
water coming out of the faucet per minute is a flow, whereas
the quantity of water in the bathtub at any point in time is a
Savings – can mean very different things. Whether referring to private,
government or nation as whole, etc.
o 1) Determine what private sector has available to spend,
Privade Disposal Income
o *Y(GDP), NFP(Net factor payments from abroad to Canadian
residents, TR(transfers from the government to the private
sector), INT(interest on the government debt), T(taxes).
Recall, GNP = Y + NFP.
o What private sector saves is simply what it has available to
spend minus what it consumes. SO…
o 2) Determine Private Sector Savings
Y YNFPTRINTT p d
S Y C
o What the government has available to spend is its tax
revenue, T, minus TR, minus INT, and what it consumes is
government expenditures, G.
*Government saving is the government surplus. SO… the government deficit
is the negative of the government surplus.
D S (T TR INT G)
*If we add private saving and government saving we obtain national saving.
S S S YNFPCG
*Can also substitute Y for C+I+G+NX. Which gives you..
CA – current account surplus.
S I CA
The Current Account Surplus is a measure of the balance of trade in goods
with the rest of the world. Reflects the fact that any domestic savings not
absorbed by domestic investment must be shipped outside the country in
the form of goods and services.
National Savings represents additions to the national wealth.
Accumulated in two ways:
Wealth is accumulated through investment, I, which is the addition
to the nations capital stock. The stock is the amount of plants,
equipment, housing, etc. that the economy has at one time.
Wealth is accumulated through current account surpluses, CA, since
a current account surplus implies that Canadian residents are
accumulating claims on foreigners. Labour Market Measurement
Employed – those who work part time or full time during the past
Unemployed – those who were not employed during the past week
but actively searched for work at some point during the last 4
Not in the labour force – those who are neither employed or
The labour force is then equal to the employed + unemployed.
Unemployment rate = number unemployed/labour force
Participation rate = labour force/total working age po
Employment/Population ratio = employment/total working age pop
Labour market tightness
The unemployment rate is a useful measure of this.
It is the degree of difficulty forms face in hiring workers.
There are two ways in which the unemployment rate may
mimeasure the tightness.
o Discouraged workers(stopped searching for work but want to
be employed), are not counted.
o Does not adjust according to how hard the unemployed are
searching for work. Chapter 3 – Business Cycle Measurement 2/5/2013 1:26:00 PM
Business cycles are quite irregular and therefore somewhat unpredictable.
Some difficulty forecasting ups and downs.
Regularities in GDP Fluctuations
Primary function of business cycle is that they are fluctuations abut
trend in real gross domestic product.
Peaks and troughs (+/- deviations from trend) Turning
Amplitude, difference between real GDP and trend line.
Number of peaks is the frequency.
Boom large number of positive trends.
Recessions large number of negative trends.
Persistent is when it stays consistently above or below trend.
Comovement is when macroeconomic variables fluctuate together
in patterns that exhibit strong regularities.
Measured in time series.
Positive vs. Negative Correlation.
How they are correlated?
Procyclical – deviations from trend are positively correlated with
the deviations from trend in real GDP.
Countercyclical – if its deviations from trend are negatively
correlated with the deviations from trend in real GDP.
Acyclical – no correlation at all.
The measure of correlation between two variables is the correlation
coefficient. (Between -1 and 1)
If the correlation is…
1 – perfectly positively correlated
-1 – perfectly negatively correlated
0 – uncorrelated
Leading and Lagging Relationships
Leading Variable if the variable tends to aid in predicting the
future path of real GDP (x is behind)
Lagging Variable if real GDP helps predict the future path of a
particular variable (x is in front) Coincident Variable neither lags or leads.
Composite index of business leading indicators
Economists argue that forecasting can be done simply by exploiting
past statistical relationships among macroeconomic variables to
project into the future.
also measures GDP
The negative relationship between the rate of change in money
wages and the unemployment rate.
Stable and reverse relationship.
Simply says lower the unemployment the higher the inflation and
Inflation – level of prices in an economy.
Purchasing power of the wage earned per hour.
Measured from the data as average money wage for all workers,
divided by price level.
Average Money Wage/Prive Level
Average Labour Activity
Measure of productivity.
Where Y is the aggregate real output and N is total labour input.
For some, Y is real GDP and N is total employment.
In most macroeconomic time series there exists a predictable
I.e. GDP tends to be lower in summer months when workers are on
vacation, Investment lower in winter months when building roads,
bridges and other types of structures are harder to build. Chapter 4 – Consumer and Firm Behaviour 2/5/2013 1:26:00 PM
The construction and analysis of a particular macroeconomic model.
We focus on the behaviour of consumers and firms in a simple model
environment with only one time period.
One period decision making for consumers and firms will limit the kinds of
macroeconomic issues we can address with the resulting model.
Given that there is only one time period, consumers and firms will make
static, as opposed to dynamic, decisions.
Dynamic decision making involves planning over more than one period, i.e.
when individuals make decisions concerning how much to spend today and
how much to save for the future.
The Representative Consumer
Consider the behaviour of a single representative consumer.
Act as a stand in for all of the consumers in the economy.
Show how to represent a consumers preferences over the available
goods in the economy and how to represent the consumers budget
The Representative Consumer’s Preferences
Suppose there are two goods that the consumer desires.
o 1) Consumption good – a physical good, which we can think
of as an aggregation of all consumer goods in the economy,
or measured aggregate consumption.
o 2) Leisure – any time not spent working. Could include
recreational activities, sleep and work at home (i.e. cleaning,
cooking, yard work, etc.)
o Assume all consumers are equal and identical and therefore,
the economy behaves as if there is only one consumer.
To determine how the consumer makes choices is to show how we can
capture the preferences of the consumer over leisure and consumption
goods is by a Utility Function.
Where U is the utility function, C is the quantity of consumption and L is the quantity of leisure.
Refer to (C,L) – c being the particular consumption quantity and l being the
particular leisure quantity as Consumption Bundle.
The utility represents how a consumer ranks the particular consumption
(Cl ) (C l )
1 1 2 2
This means that the consumer values and/or gets more satisfaction from
bundle 1 than 2.
Note: the actual level of utility is irrelevant; all that matters for the
csumer is what the level of utility is from a given consumption bundle
relative to another one.
More is always preferred to less.
The consumer likes diversity in his/her bundle. (has choices within)
Consumption and leisure are normal goods.
o Normal – quantity of good