GDP, Inflation, and Unemployment • The 3 major macroeconomic performance indicators • Definitions & measurement • Flows & Stocks
Measuring GDP, Inflation, and Unemployment
– Flows: measured per period of time • income statement
– Stocks: measured at a point in time • balance sheet
August 31 & September 2, 1999
1
August 31 & September 2, 1999
2
Figure 2-1 The Circular Flow of Income and Consumption Expenditures
A Simple Model of the Economy • Assumptions – Only business firms and households – Only business firms produce goods & services – Only households own factors of production – There is no savings; there is no investment » Figure 2-1
August 31 & September 2, 1999
3
August 31 & September 2, 1999
A Simple Model of the Economy
Extending the Simple Model
• Conclusions
• Gross Private Domestic Investment
– Income (Y) = Factor payments – Consumption (C) = Production – Income (Y) = Consumption expenditures (C) – Income (Y) = Production of goods and services
– Adds to the economy’s stock of incomeyielding assets – Classification • Fixed Investment – Business Investment » Structures » Equipment – Residential Investment
– Output can be measured from either: • the income side, or • the product side August 31 & September 2, 1999
4
• Inventory Investment 5
August 31 & September 2, 1999
6
1
Figure 2-3 Introduction of Saving and Investment to the Circular Flow Diagram
Extending the Simple Model • Assumptions – Only business firms and households – Only business firms produce goods & services – Only households own factors of production – Households can save – Business firms can invest » Figure 2-3
August 31 & September 2, 1999
7
August 31 & September 2, 1999
Extending the Simple Model
Extending the Simple Model
• Development of the Capital Markets
• Conclusions
– Households buy stocks and bonds issued by the business firms – Households deposit savings in financial institutions that lend the money to business firms
August 31 & September 2, 1999
– Savings “leaks” from the income/consumption stream – Investment “injects” spending back into the system – Leakages and injections must equal
9
August 31 & September 2, 1999
Extending the Simple Model
Extending the Simple Model
• Net Exports
• Government
– Exports: domestic production/foreign sales
10
– Types of expenditures
• creates domestic income, not spending
• government purchases • transfer payments
– Imports: foreign production/domestic sales
– Classification of government purchases
• creates domestic spending, not income
• Federal government
– Net exports: exports - imports
– Defense – Nondefense
• a component of GDP • if exports > imports, then GDP is higher • if exports < imports, then GDP is lower
• State government • Local government
– Net foreign investment August 31 & September 2, 1999
8
» Figure 2-4 11
August 31 & September 2, 1999
12
2
Figure 2-4 Introduction of Taxation, Government Spending, and the Foreign Sector to the Circular Flow Diagram
Extending the Simple Model • With equations Y=E E = C + I + G + NX Y+F=C+S+R Y = C + S + (R - F) Y=C+S+T
August 31 & September 2, 1999
13
Extending the Simple Model
August 31 & September 2, 1999
14
Extending the Simple Model • Government Budget Deficit
C + S + T = C + I + G + NX -C = -C . S+T= I + G + NX
G - T = S - (I + NX) • Increased budget deficit can be financed by – more private savings – less private investment – less foreign investment/more foreign borrowing
• “Leakages” must equal “Injections”
August 31 & September 2, 1999
15
August 31 & September 2, 1999
Measuring GDP
Measuring GDP
• National Income & Product Accounts
• Defining GDP:
– NIPA or National Accounts – Accounting for all of the flows of income and expenditures in the economy
16
– all currently produced goods and services that are sold through the market (but are not resold) – Currently produced • No used products • No transfer payments • No capital gains
August 31 & September 2, 1999
17
August 31 & September 2, 1999
18
3
Measuring GDP
Measuring GDP
• Defining GDP (continued)
• Defining GDP (continued)
– Sold on the market
– But not resold
• No value of non-paid personal time • No externalities • No illegal activities • The puzzling case of consumer durable spending • The puzzling case of government expenditures
August 31 & September 2, 1999
• during the current time period • intermediate versus final goods • double counting versus value added » Figure 2-2
19
Figure 2-2 The Contribution of One Loaf of Bread to Consumption Expenditures and Income Created
August 31 & September 2, 1999
20
Measuring GDP • GDP versus GNP – GDP: goods and services produced in the US regardless of who owns the factors of production – GNP: goods and services produced by US owned factors of production regardless of where the production takes place – GNP < GDP
August 31 & September 2, 1999
21
Measuring GDP
August 31 & September 2, 1999
22
Measuring GDP Oranges
• Real versus Nominal Magnitudes – Nominal magnitudes: include price effects – Real magnitudes: strip price effects out
Year 1 Year 2
Apples
Economy
P
Q
PQ
P
Q
PQ
PQ
Index
$ 0.10 $ 0.20
30 20
$ 3.00 $ 4.00
$ 0.20 $ 0.25
10 20
$ 2.00 $ 5.00
$ 5.00 $ 9.00
1.00 1.80
• expressed in the prices of an arbitrarily chosen base year, currently 1992
• Calculating GDP – must add together all goods and services – must use prices to get values – since prices change, real GDP will depend on what prices we pick
August 31 & September 2, 1999
23
August 31 & September 2, 1999
24
4
Measuring GDP
Measuring GDP
Oranges
Year 1 Year 2
Apples
Economy
Oranges
P
Q
PQ
P
Q
PQ
PQ
Index
$ 0.10 $ 0.20
30 20
$ 3.00 $ 4.00
$ 0.20 $ 0.25
10 20
$ 2.00 $ 5.00
$ 5.00 $ 9.00
1.00 1.80
$ 3.00 $ 2.00
$ 0.20 $ 0.20
10 20
$ 2.00 $ 4.00
$ 5.00 $ 6.00
1.00 1.20
Year 1 Year 2
Measured at Year 1 Prices Year 1 Year 2
$ 0.10 $ 0.10
30 20
Apples
Economy
P
Q
PQ
P
Q
PQ
PQ
Index
$ 0.10 $ 0.20
30 20
$ 3.00 $ 4.00
$ 0.20 $ 0.25
10 20
$ 2.00 $ 5.00
$ 5.00 $ 9.00
1.00 1.80
$ 3.00 $ 2.00
$ 0.20 $ 0.20
10 20
$ 2.00 $ 4.00
$ 5.00 $ 6.00
1.00 1.20
$ 6.00 $ 4.00
$ 0.25 $ 0.25
10 20
$ 2.50 $ 5.00
$ 8.50 $ 9.00
1.00 1.06
Measured at Year 1 Prices Year 1 Year 2
$ 0.10 $ 0.10
30 20
Measured at Year 2 Prices Year 1 Year 2
$ 0.20 $ 0.20
30 20
Geometric mean (year 2) =
August 31 & September 2, 1999
25
Measuring Inflation
26
Measuring Inflation
Oranges
Year 1 Year 2
1.13
August 31 & September 2, 1999
Apples
Oranges
Economy
P
Q
PQ
P
Q
PQ
PQ
Index
$ 0.10 $ 0.20
30 20
$ 3.00 $ 4.00
$ 0.20 $ 0.25
10 20
$ 2.00 $ 5.00
$ 5.00 $ 9.00
1.00 1.80
Year 1 Year 2
Apples
Economy
P
Q
PQ
P
Q
PQ
PQ
Index
$ 0.10 $ 0.20
30 20
$ 3.00 $ 4.00
$ 0.20 $ 0.25
10 20
$ 2.00 $ 5.00
$ 5.00 $ 9.00
1.00 1.80
$ 0.20 $ 0.25
10 10
$ 2.00 $ 2.50
$ 5.00 $ 8.50
1.00 1.70
Measured at Year 1 Quantities Year 1 Year 2
August 31 & September 2, 1999
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Measuring Inflation Apples
Economy
Q
PQ
P
Q
PQ
PQ
Index
$ 0.10 $ 0.20
30 20
$ 3.00 $ 4.00
$ 0.20 $ 0.25
10 20
$ 2.00 $ 5.00
$ 5.00 $ 9.00
1.00 1.80
$ 0.20 $ 0.25
10 10
$ 2.00 $ 2.50
$ 5.00 $ 8.50
1.00 1.70
$ 0.20 $ 0.25
20 20
$ 4.00 $ 5.00
$ 6.00 $ 9.00
1.00 1.50
$ 0.10 $ 0.20
30 30
$ 3.00 $ 6.00
$ 0.10 $ 0.20
20 20
$ 2.00 $ 4.00
August 31 & September 2, 1999
28
– 25% rotation
• Employment Status of the Population – Population
Measured at Year 2 Quantities Year 1 Year 2
$ 3.00 $ 6.00
• Survey 60,000 households monthly
P
Measured at Year 1 Quantities Year 1 Year 2
30 30
Measuring Unemployment
Oranges
Year 1 Year 2
$ 0.10 $ 0.20
• Total labor force – Military – Civilian labor force » employed » unemployed
• Not in labor force Geometric mean (year 2) =
August 31 & September 2, 1999
1.60
29
August 31 & September 2, 1999
30
5
Measuring Unemployment
Measuring Unemployment
• The Unemployment Rate:
• Shortcomings of the Unemployment Rate
– Ratio of the number of people unemployed to the number in the labor force, expressed as a percentage
– What does it mean to be employed? • Involuntary part-timers
– What is the cost of unemployment? • Family head or teenager?
Unemployment Rate =
unemployed civilian labor force
* 100
– Does anybody fall through the cracks? • Discouraged workers
• Do these Shortcomings Matter? August 31 & September 2, 1999
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August 31 & September 2, 1999
Measuring Unemployment
Measuring Unemployment
• Labor Force Participation Rate:
• Employment-Population Ratio:
– The ratio of the number of people in the labor force to the adult population, expressed as a percentage
32
– The ration of the number of people employed to the adult population, expressed as a percentage EPR = Employed / Adult Population * 100
LFPR = Labor Force / Adult Population * 100
August 31 & September 2, 1999
33
August 31 & September 2, 1999
34
Figure 2-6 The U.S. Ratio of Actual to Natural Real GDP (Y/Y N) and the Unemployment Rate, 1965–96
GDP and Unemployment • Okun’s Law – There is a close negative relationship between • the output ratio, Y/Y(n), and • the unemployment rate » Figure 2-6
– The percentage point change in the unemployment rate is approximately 1/2 times the percentage point change in the output ratio, but in the opposite direction August 31 & September 2, 1999
35
August 31 & September 2, 1999
36
6
Okun’s Law U = U(n) - h * ( 100 * ( Y / Y(n) ) - 100 ) U
U(n)
h
Y / Y(n)
11.2 8.7 6.2 3.7 1.2
6.2 6.2 6.2 6.2 6.2
0.5 0.5 0.5 0.5 0.5
0.90 0.95 1.00 1.05 1.10
August 31 & September 2, 1999
37
7
The Goals of Stabilization Policy • Costs of a Fully Anticipated Inflation: Creeping Inflation versus Hyperinflation
The Goals of Stabilization Policy: Low Inflation and Low Unemployment
– Welfare Cost of Lower Real Money Balances • Money does not receive a market interest rate – No interest is paid on currency – No interest is paid on required reserves – Below market rates are subsidized by deposit insurance
• Several consequences – Convenience use of money is reduced – “Shoe-leather” costs – Costs of an anticipated hyperinflation August 31 & September 1, 1999
1
August 31 & September 1, 1999
The Goals of Stabilization Policy
The Goals of Stabilization Policy
• Costs of a Fully Anticipated Inflation: Creeping Inflation versus Hyperinflation
• Costs of a Fully Anticipated Inflation: Creeping Inflation versus Hyperinflation
– Interest Rates and Taxation
– Summary: Costs of Inflation
• Nominal interest rates do not always change pointfor-point with inflation; changes in real interest rates redistributes income • If nominal interest income is taxed and nominal interest costs are tax deductible then income is redistributed
August 31 & September 1, 1999
28
• From unanticipated inflation – Redistribution of income from creditors to debtors
• From anticipated inflation – – – –
“Shoe-leather” costs from minimizing real cash balances Changes in relative costs Redistribution of income if real interest rates change Redistribution of income from non-inflation neutral tax system
August 31 & September 1, 1999
The Goals of Stabilization Policy
The Goals of Stabilization Policy
• Indexation and Other Reforms to Reduce the Costs of Inflation
• Why the Unemployment Rate Cannot Be Reduced to Zero
– Introduction
29
– Distinguishing the Types of Unemployment
• There are a number of reforms that can substantially cut the costs imposed by inflation
– Decontrol of Financial Institutions – Indexed Bonds
• Cyclical unemployment – Difference between actual and natural unemployment – Can be negative
• Turnover unemployment – Frictional unemployment
• i = r(0) + p
• Mismatch unemployment
– Index Tax System
– Structural unemployment
• Turnover and mismatch = natural unemployment
• Institute an inflation-neutral tax system August 31 & September 1, 1999
27
30
August 31 & September 1, 1999
31
1
The Goals of Stabilization Policy
The Goals of Stabilization Policy
• Sources of Mismatch Unemployment
• Turnover Unemployment and Job Search
– Causes of and Cures for Mismatch Unemployment: Mismatch Skills
– Reasons for Turnover Unemployment • The Economics of Job Refusal – Theory of “search” unemployment – Job search theory treats unemployment as a socially valuable, productive activity as unemployed individuals “invest” in their job search – Cost is cost of search plus loss wages » Benefit is “better” job and higher wages – Government’s ability to reduce is limited
• Lack of job training • Inflexibility of relative wages • Discrimination
– Causes of and Curves for Mismatch Unemployment: Mismatch Location
• Effects of Unemployment Compensation
– The Human Costs of Recessions August 31 & September 1, 1999
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August 31 & September 1, 1999
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2
