Chapter 2: Data of Macroeconomics

Prof. Chris Foote

Harvard University
Department of Economics

Feb. 1, 2008

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Outline

The Value of Economic Activity: GDP

Cost of Living: CPI

Data from the Labor Market

Case Study: Labor Force Participation and the Baby Boomers

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The Value of Economic Activity: GDP

GDP as an Economic Concept

Three equivalent ways to think of GDP
Total income of everyone in the economy
Total expenditure of everyone in the economy
Total production of everyone in the economy

Intended to summarize how much economic activity is going

during a specific period

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The Value of Economic Activity: GDP

The Simple Circular Flow Diagram

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The Value of Economic Activity: GDP

Why should we care about GDP?

Yet the gross national product does not allow for the health of our
children, the quality of their education, or the joy of their play. It does
not include the beauty of our poetry or the strength of our marriages;
the intelligence of our public debate or the integrity of our public
officials. It measures neither our wit nor our courage; neither our
wisdom nor our learning; neither our compassion nor our devotion to
our country; it measures everything, in short, except that which makes
life worthwhile. And it tells us everything about America except why we
are proud that we are Americans.

Robert F. Kennedy
Speech at the University of Kansas
March 18, 1968

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The Value of Economic Activity: GDP

GDP and Absolute Poverty

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The Value of Economic Activity: GDP

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The Value of Economic Activity: GDP

Rules for computing GDP

Gross Domestic Product (GDP) is the market value of all final goods
and services produced within an economy in a given period of time.
1

Uses prices to add up disparate goods into a single number

GDP = (Price of Apples Quantity of Apples) +
(Price of Oranges Quantity of Oranges)

Only new goods are included

Inventories (e.g., goods produced by not sold) are considered

investment by firms

Includes only final goods not intermediate inputs

Some values are imputed

Housing and government services are imputed

Services from durable goods (cars) and home production are not

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The Value of Economic Activity: GDP

How big is GDP?: Example 1

Former Ec 10 Head
Former Fed Governor
George W. Bushs first
Director of the National
Economic Council

Figure 1.

In response to reporters
question, said that Iraq
War would cost no more
than one to two percent of
GDP
GDP in 2002 $10.4
trillion
$10.4 trillion .02 $200
billion
Later fired

Lawrence B. Lindsey

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The Value of Economic Activity: GDP

How big is GDP?: Example 2

Congress and President are working toward a stimulus package
to avert recession in 2008
How big should this package be?
Many say around 1% of GDP
GDP in 2007:Q3 $14.1 trillion
$14.1 trillion .01 $141 billion
Its an election year, so theyve rounded up to $150 billion

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The Value of Economic Activity: GDP

Real vs. Nominal GDP

Nominal GDP uses current prices to aggregate goods
Real GDP holds prices constant over time, using a base year

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The Value of Economic Activity: GDP

Real vs. Nominal GDP (cont)

Nominal GDP in 2008:
(2008 Price of Apples 2008 Quantity of Apples)+
(2008 Price of Oranges 2008 Quantity of Oranges)

Real GDP in 2008, using 2000 as base-year for prices:

(2000 Price of Apples 2008 Quantity of Apples)+
(2000 Price of Oranges 2008 Quantity of Oranges)

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The Value of Economic Activity: GDP

Real vs. Nominal GDP using some different notation

Nominal GDP in 2008:

Pi2008 Qi2008

Real GDP in 2008, using 2000 as base-year:

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Pi2000 Qi2008

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The Value of Economic Activity: GDP

An Aside on Chain-Weighted GDP

In practice, using prices from a single year over long periods is not
a good idea
Dont want to use prices from a base year of 1900 to measure
GDP in 2000
In the old days, the government would use update the base years
every 5 years or so
Since 1995, it uses a chain-weight method, which updates on a
continuous basis
Statistical details are not important, so just think of real GDP as
above

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The Value of Economic Activity: GDP

The GDP Deflator

Sometimes called the implicit price deflator
Intended to measure what is happening with prices
Nominal GDP 2008
Real GDP 2008
P 2008 2008
P
Q
= Pi i2000 i2008
Qi
i Pi

GDP Deflator 2008 =

[assumes that 2000 is base-year for real GDP]

Rearranging shows that nominal GDP reflects both prices and
quantities:
Nominal GDP = Real GDP GDP Deflator
Easiest to see GDP deflator as a deflator this way:
Nominal GDP
Real GDP =
GDP Deflator
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The Value of Economic Activity: GDP

Components of GDP

GDP = C + I + G + NX
= C + I + G + (EX IM)
Consumption (C) goods and services bought by households
Investment (I) goods bought for future use
Nonresidential fixed investment (factories and machines for firms)
Inventory investment
Residential investment (housing for people)

Government purchases (G) goods bought by all levels of

government
Not the same as government spending, which includes transfers
like Social Security

Net exports (NX) positive when we run a trade surplus

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The Value of Economic Activity: GDP

Components of Nominal GDP: 1929-2006

90
80
70

Consumption

60

Percent Share

50
40
30
Government Purchases
20
10

Investment

0
Net Exports
-10
-20
1929

1934

1939

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1944

1949

1954

1959

1964

1969

Data

1974

1979

1984

1989

1994

1999

2004

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The Value of Economic Activity: GDP

Components of GDP in 2005

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The Value of Economic Activity: GDP

The importance of housing in todays outlook

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Cost of Living: CPI

CPI as a cost of living index

Weighted average of things that consumers buy
Weights reflect importance of items in consumers baskets
Quantity weights are (essentially) fixed in a base year
Using a base year of 2000 and indexing goods by i we have
P 2008 2000
P
Q
CPI2008 = Pi i2000 i2000
Qi
i Pi

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Cost of Living: CPI

How to use CPI

Problem: We want to calculate inflation between 2005 and 2006
We are going to use CPI with 2000 as base year
P 2006 2000
P
Q
CPI2006 = Pi i2000 i2000
Q
iP
P i2005 i2000
P
Q
CPI2005 = Pi i2000 i2000
Qi
i Pi
Dividing CPI2006 by CPI2005 gives
CPI2006
=
CPI2005

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P 2006 2000
P
Q
P i i2000 i2000
Qi
i Pi
P 2005 2000
P
Q
P i i2000 i2000
Qi
i Pi

Data

P 2006 2000
P
Q
= Pi i2005 i2000
Qi
i Pi

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Cost of Living: CPI

CPI vs. GDP deflator in theory

1

GDP deflator measures the price of all goods and services

produced, while CPI measures prices for consumption goods only

GDP deflator measures prices of goods produced domestically,

while CPI includes imported consumption goods
Weights in CPI are fixed, while GDP deflator weights are changing
over time

You can prove this to yourself by working through the previous slide
using GDP deflator rather than CPI

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Cost of Living: CPI

Consumer Price Index: 1982-2007

2.5

Base Year Basket at 2002 Prices

Base Year Basket at Base Year Prices
Base Year Basket at 1992 Prices
Base Year Basket at Base Year Prices

Index (Base Year Value = 1)

2.0

1.80
1.5

1.40
1.0

0.5

Inflation between 1992 & 2002

(1.80 / 1.40 ) = 1.29
or 29%

Base Year Basket at Base Year Prices

Base Year Basket at Base Year Prices

0.0
1982

1984

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1986

1988

1990

1992

1994

Data

1996

1998

2000

2002

2004

2006

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Cost of Living: CPI

GDP Deflator = Nominal GDP / Real GDP

(not real data)
2.5

2002 Basket at 2002 Prices

2002 Basket at Base Year Prices
1992 Basket at 1992 Prices
1992 Basket at Base Year Prices

Index (Base Year Value = 1)

2.0

1.5

1.0

Inflation calculation between 1992 & 2002

does not compare the same baskets of goodss
0.5

Base Year Basket at Base Year Prices

Base Year Basket at Base Year Prices

0.0
1982

1984

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1986

1988

1990

1992

1994

Data

1996

1998

2000

2002

2004

2006

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Cost of Living: CPI

CPI vs. GDP deflator in practice

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Cost of Living: CPI

Does the CPI overstate inflation?

There are a number of reasons why changes in the CPI may overstate
inflation
1

Substitution bias: CPI uses fixed weights that dont allow for
substitution to cheaper goods

New goods: Hard to introduce new goods if they were not around
in the base year

Quality changes: TVs are more expensive today, but their quality
is much better
Boskin Commission (which included Harvard Prof. Dale
Jorgenson): Overstatement is around 1.1% per year
Since then, improvements have brought the bias below 1%, but its
still there

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Data from the Labor Market

The Household Survey

Monthly survey of about 75,000 people
Among many other questions, asks their labor market state
Employed (E) held a job during the survey week
Unemployed (U) no job, but looking within the past four weeks
Out of the labor force (N) full-time students, homemakers, etc.

Labor force (LF) is E + U

Participation rate is

LF
LF +N

Unemployment rate (UR) is

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LF
POP
U
U
LF = E+U

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Data from the Labor Market

Distribution of labor market states

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Data from the Labor Market

Unemployment Rate
12

Percent of Labor Force

10

0
1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005

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Data from the Labor Market

The Establishment Survey

Monthly survey of about 160,000 businesses
Generates monthly nonfarm payroll figure, announced with
unemployment rate
Key conceptual differences from household-survey employment:
Payroll number includes multiple jobholders
Payroll number excludes self-employed
Payroll number doesnt pick up firm births and deaths perfectly

Even controlling for these differences, payrolls appear more

cyclical than household-survey employment
No one knows why

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Data from the Labor Market

Change in Nonfarm Employment: 1995:1 - 2008:1

600
500
400

Thousands of Payroll Jobs

300
200
100
0
-100
-200
-300
-400
1995

1996

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1997

1998

1999

2000

2001

Data

2002

2003

2004

2005

2006

2007

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Data from the Labor Market

Cyclicality in Three Measures of Employment

150000
145000
140000

Employment
from Household
Survey

135000

Thousands

130000
125000

Household-Survey
Employment made
as comparable as
possible with Payroll
Employment

120000
115000
110000

Employment from
Payroll Survey

105000
100000
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

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Case Study: Labor Force Participation and the Baby Boomers

Trends in labor force participation

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Case Study: Labor Force Participation and the Baby Boomers

Labor Force Participation Rate (Ages 16+)

69

67

Percent of Population

65

63

61

59

57

55
1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005

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Case Study: Labor Force Participation and the Baby Boomers

U.S. Births Per 1,000 Population

35

30

25

20

15

10

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2002

1999

1996

1993

1990

1987

1984

1981

1978

1975

1972

1969

1966

1963

1960

1957

1954

1951

1948

1945

1942

1939

1936

1933

1930

1927

1924

1921

1918

1915

1912

1909

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Case Study: Labor Force Participation and the Baby Boomers

Figure 2. This dotted line given an indication of how aggregate labor

force participation might decline as the baby boom ages. (Source:
Aaronson et al. [2006])
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Case Study: Labor Force Participation and the Baby Boomers

Labor Force Participation Rates, By Age

75

All Ages
(16+)
70

Percent of Population

Ages 25+

65

60

Ages
16-24

55

50
1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005

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