Chapter 10

Measuring Macroeconomic Variables and Policy Issues

Measuring GDP and Inflation

Mankiw, G. (2008) Brief Principles

of Economics, 5rd edition, South-
Western Cengage Learning (Ch. 2)

Parkin, M. (2008)
Macroeconomics, 8th edition,
Pearson International Edition
(Ch5).

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 Warm UP

https://www.imf.org/en/Publications/WEO/Issues/2019
/01/11/weo-update-january-2019

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 Measuring GDP
Learning Outcomes
How to measure GDP using:

value added,
income and
expenditure approaches

The difference between real and nominal GDP

Few usages of GDP and policy issues

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 Macroeconomic Indicators (Class 1)
GDP fluctuations over long term trend growth - RM

First years of independence

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Class (1) Circular Flow of Income with
Injections and Leakages

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THE MEASUREMENT OF GDP

If we consider the Circular Flow of Income-

than we calculate GDP :
•as a the market value of all finished goods
and services,
•by summing up the value of all incomes (from
wages, rent, interest & profit) or
•by summing up the value of all expenditures
in the economy.

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 THE MEASUREMENT OF GDP
Three approaches
• Gross domestic product (GDP) is a measure of the
total income, total expenditures and total production of
an economy.
 Total Production – net value of goods and services
produced by firms (Production approach)

• Total Income – value of earnings of all factors of

production (Income approach)

• Total Expenditures (spending): C + I + G + NX

(Expenditure approach)

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 THE MEASUREMENT OF GDP
Definition
GDP is the market value of all final goods and services produced within a
country in a given period of time.
•“GDP is the Market Value . . .”
– Output is valued at market prices (Q*P)
•“. . . Of All Final . . .”
– It records only the value of final goods and services, not intermediate goods and
services (the value is counted only once)
•“. . . Goods and Services . . . “
– It includes both tangible goods (food, clothing, cars) and intangible services
(haircuts, housecleaning)
•“. . . Produced . . .”
– It includes goods and services currently produced, not involving those produced in
the past
•“ . . . Within a Country . . .”
– It measures the value of production within the geographic borders of a country
•“. . . In a Given Period of Time.”
– It measures the value of production that takes place within a specific interval of
time, usually a©year or a quarter
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 THE MEASUREMENT OF GDP
Income approach
Total Income – value of earnings of all factors of
production (labour, capital, land, entrepreneurship):

GDP is the sum of :

oCompensations of employees (net wages and salaries, plus taxes withheld from
earnings plus benefits such social and pension fund contributions)
oNet interest (interest from lending and borrowing)
oRental income (payment received from rented resources)
oCorporate profit (corporations’ profit, some of which is payed as dividends and some of
which is retained by corporations as undistributed profits)
oProprietors’ income (income earned by the owner-operator business –small business)

Two adjustments to get GDP:

Indirect taxes minus subsidies are added to get from factor cost to market prices.
Depreciation is added to get from net domestic product to gross domestic product.
Depreciation (consumption of fixed capital) - a decrease in the current value of producer's fixed
assets due to the physical use, oldness and accidental damages.
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 THE MEASUREMENT OF GDP
Expenditures approach
Total Expenditures: C + I + G + NX
•Consumption (C):
– The spending by households on goods and services, with the exception
of purchases of new housing.
•Investment (I):
– The spending on capital equipment and buildings, including new housing
and change in business inventories.
•Government Purchases (G):
– The spending on goods and services (including wages) by local and
state governments.
– Does not include transfer payments because they are not expenditures
on goods or services.
•Net Exports (NX):
– Exports minus imports

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 GDP by Production Approach-RM
Т-М05: Бруто-домашен производ според методите на пресметка, по тековни цени

T-M05: Gross domestic product, at current prices

 
во милиони денари     in million denars

 
2014 2015 2016
ПРОИЗВОДЕН МЕТОД       PRODUCTION APPROACH

1 Производство (основни цени) 982 380 1 042 294 1 098 348 1 Production (basic prices)

2 Меѓуфазна потрошувачка 524 252 553 886 582 747 2 Intermediate consumption
(набавни цени) (purchaser's prices)

3=1-2 Додадена вредност (основни 458 128 488 408 515 601 3=1-2 Value added (basic prices)
цени)

4 Даноци на производи минус 69 503 70 546 79 194 4 Taxes on products less

субвенции subsidies

5=3+ Бруто-домашен производ 527 631 558 954 594 795 5=3+4 Gross domestic product
4 (пазарни цени) (market prices)
Source: SSO © The McGraw-Hill Companies, 2009
 GDP by Income Approach-RM
Т-М05: Бруто-домашен производ според методите на пресметка, по тековни цени

T-M05: Gross domestic product, at current prices

во милиони денари       in million denars
  2014 2015 2016
ДОХОДОВЕН МЕТОД     INCOME APPROACH
1 Средства на 176 316 185 174 201 899 1 Compensation of
вработените employees

2 Потрошувачка на 95 314 97 008 99 905 2 Consumption of fixed

фиксен капитал (-) capital (depreciation)

3 Нето-деловен вишок 190 545 210 247 216 972 3 Net operating surplus
(profits)

4 Други даноци на - 4 047 - 4 021 - 3 175 4 Other taxes on production

производство - нето - net

5=1+2+3+4 Додадена вредност 458 128 488 408 515 601 5=1+2+3+4 Value added (basic prices)
(основни цени)

6 Даноци на производи 69 503 70 546 79 194 6 Taxes on products less

минус субвенции subsidies

7=5+6 Бруто-домашен 527 631 558 954 594 795 7=5+6 Gross domestic product
производ (пазарни (market prices)
цени)
Source: SSO © The McGraw-Hill Companies, 2009
GDP by Production Approach-RM

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 GDP by Expenditure Approach-RM
Т-М05: Бруто-домашен производ според методите на пресметка, по тековни цени
T-M05: Gross domestic product, at current prices
во милиони денари       in million denars
ТРОШОЧЕН МЕТОД     EXPENDITURE APPROACH
1 Финална потрошувачка на 368 311 384 798 398 026 1 Household final consumption,
домаќинствата, вклучувајќи including NPISHs
НПИСД

2 Финална јавна потрошувачка 90 290 94 890 91 777 2 General government final

consumption

3 Инвестиции во основни 123 549 133 254 145 040 3 Gross fixed capital formation
средства

4 Промена на залихи1) 35 901 36 315 47 973 4 Changes in inventories 1)

5 Нето-стекнување вредности 397 373 352 5 Net acquisition of valuables

6 Извоз на стоки и на услуги 251 484 272 423 301 346 6 Export of goods and services
7 Увоз на стоки и на услуги 342 301 363 099 389 720 7 Import of goods and services

8=1+2+3+4+5+6 Бруто-домашен производ 527 631 558 954 594 795 8=1+2+3+4+5+6 Gross domestic product
-7
(пазарни цени) -7 (market prices)
Source: SSO © The McGraw-Hill Companies, 2009
 Expenditures approach
Components of GDP in RM (share in %)

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 Expenditures approach
Components of GDP in RM (contributions to growth)

Source: SSO
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THE COMPONENTS OF GDP

Application:
What components of GDP, if any, would each
of the following transactions affect:
a. A family buys a new refrigerator.
b. Aunt Jane buys a house.
c. Renault sells a Clio from its inventory.
d. The government repairs a highway.
e. Your parents buy a bottle of French wine.

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REAL VERSUS NOMINAL GDP
• Nominal GDP values the production of goods and
services at current prices (prices that prevail in that
year).
• Nominal GDP uses current prices to place a value on
the economy’s production (P*Q).
• Nominal GDP can increase either because prices rise
or because quantities rise.

• Real GDP values the production of goods and services

at constant prices (some base - year prices).
• Real GDP uses constant base-year prices to place a
quantity on the economy’s production (Q).

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 REAL VERSUS NOMINAL GDP
• Nominal GDP is not a good gauge of economic well-being.
• Nominal GDP does not accurately reflect how well the
economy can satisfy the demands of households, firms, and
the government.

• Real GDP is a better measure of economic well-being.

• Real GDP counts the economy’s output of goods and
services without being influenced by changes in prices.
• For this purpose, economists use real GDP

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Real GDP - Economic Growth Rate

• We use Real GDP to calculate economic

growth rate.
• The economic growth rate is the
percentage change in the quantity of
goods and services produced from one to
the next year

Economic growth rate (%) = Real GDPt+1 – Real GDPt * 100

Real GDPt

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Example: Real and Nominal GDP

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Real GDP - Economic Growth Rate
Practice
(e.x RM)
Real GDP
(reference year Economic
2005, in mil. growth (%) Economic growth rate %
denars) (2008/2007)=
 
2007 345.285  (364.179 - 345.285) / 345.285
2008 364.179 5,5 *100 = 5.5%
2009 362.873
2010 375.061
2011 383.837
2012 382.087
2013 393.262
2014 407.536
2015 423.249
2016 435.305

2017 1) 436.352Companies, 2009

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 The GDP Deflator

• The GDP deflator is a measure of the

price level
• It tells us the rise in nominal GDP that
is attributable to a rise in prices rather
than a rise in the quantities produced.
Nominal GDP
GDP Deflator (index) = * 100
Real GDP

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Example: Real and Nominal GDP

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 Practice
• In an economy:
Real GDP for year 2014 (base year = 1996)
is $200 billion
GDP deflator 2014 (base year = 1996) is
120
Calculate the Nominal GDP for 2014

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 Practice

• An economy’s Nominal GDP, Real GDP, and

GDP deflator data are given as follows:
• a) Fill in the blanks and show your work.
• b) Calculate the economic growth rate from
2014 to 2015.
  2014 2015

NGDP (bil. $) 12 12.5

RGDP (bil. $)   10.4

Deflator (index) 118  

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 Few usages of GDP

• GDP - measuring level of production

• GDP per capita – measuring living
standard
• GDP growth – measuring economic
progress
• GNI – Gross National Income - , etc.

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 GDP usages - RM
T-01: Бруто-домашен производ, 2003 – 2017
T-01: Gross domestic product, 2003-2017
БДП по жител во БДП во милиони
БДП во тековни цени Стапки на реален
  евра (по тековен евра (по тековен БДП-дефлатор
(во милиони денари) раст на БДП во %
курс) курс)
GDP per capita
GDP in million
GDP at current prices in Euros (at GDP real GDP
  Euros (at current
(in million denars) current growth rates in % deflator
exchange rate)
exchange rate)
2003 268 694 2 164 4 386 2,2 101,7
2004 280 786 2 252 4 578 4,7 99,8
2005 308 447 2 470 5 032 4,7 104,9
2006 334 840 2 682 5 472 5,1 103,3
2007 372 889 2 982 6 095 6,5 104,6
2008 414 890 3 308 6 772 5,5 105,5
2009 414 622 3 300 6 767 -0,4 100,3
2010 437 296 3 459 7 109 3,4 102,0
2011 464 186 3 665 7 544 2,3 103,7
2012 466 703 3 680 7 585 -0,5 101,0
2013 501 891 3 948 8 150 2,9 104,5
2014 527 631 4 141 8 562 3,6 101,4
2015 558 954 4 382 9 072 3,9 102,0
2016 594 795 4 659 9 657 2,8 103,5
20171) 616 600 4 827 10 014 0,2 103,4
1)
Претходни податоци
1) © The McGraw-Hill Companies, 2009
Preliminary data
GDP AND ECONOMIC WELL-BEING

• GDP is the best single measure of the

economic well-being of a society.

• GDP per person (per capita) provides a

measure of average income per person in
the economy.

• Higher GDP per person indicates a higher

standard of living (more and better schools,
hospitals…)

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 GDP Policy Issues
GDP Per Capita

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GDP AND ECONOMIC WELL-BEING
• GNP - Gross National Product is broader concept than
GDP
• GNP - measures the total income earned by nationals
(domestically and internationally)
• GDP – measured the total income produced domestically
(within the counties’ borders)
• To obtain GNP - we add to GDP receipts of factor income
(wages, profit, and rent) from the rest of the world and
subtract payments of factor income to the rest of the world:
• GNP = GDP + Factor Payments from Abroad − Factor
Payments to Abroad.

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 GNP -RM
GDP at
In million current Net Primary Gross National
euros  prices Income Income (GNP)
  1 2 3=1+2

2003 4.386 -53 4.333

2004 4.578 -30 4.548

2005 5.032 -88 4.944

2006 5.472 -21 5.451

2007 6.095 -281 5.814

2008 6.772 -94 6.678

2009 6.767 -47 6.720

2010 7.109 -100 7.009

2011 7.544 -131 7.413

2012 7.585 -164 7.421

2013 8.150 -193 7.957

2014 8.562 -161 8.401

2015 9.072 -286 8.786

2016 9.657 -384 9.273

2017 © The
10.014
McGraw-Hill -398 9.616
Companies, 2009
GDP AND ECONOMIC WELL-BEING

• But imperfect measure:

• “ GDP 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, the strength of our
marriages, the intelligence of our public
debate or the integrity of our public
officials…”
Senator Robert Kennedy (1968) when
running for a president

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 GDP AND ECONOMIC
WELL-BEING
• Some things that contribute to well-
being are not included in GDP.
– The value of leisure.
– The value of a clean environment.
– The value of almost all activity that takes
place outside of markets, such as the
value of the time parents spend with their
children and the value of volunteer work.

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Who wins at the Olympics?
• Certainly, nations with bigger population
• Is that always true? Think of India,
Bangladesh, Indonesia, China
• 40% of world population but 6% of medals
• Total GDP (not GDP per capita)
• Host country
• Former communist countries (more
resources)

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Benefits From Growth in GDP

• Employment

• Investment

• Higher taxes – improved public services?

– Health, education

• But higher growth may stimulate inflation

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 Trade-offs

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 Measuring Inflation
Learning Outcomes
• Define inflation and Types of Inflation
• Measuring inflation (Consumer Price
Index-CPI)
• Costs of inflation
• Deflation and Hyperinflation
• Adjusting nominal variables for inflation

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Macroeconomic Indicators
Inflation – RM (Class 1)

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 Inflation

• Inflation refers to a situation in which the

economy’s overall price level is rising.

• The inflation rate is the percentage change in

the price level from the previous period.

• Inflation rate is a measure of how fast prices

are rising.

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 Inflation

• Determinants or types of inflation:

– Demand Pull – a rise in aggregate demand
– Cost Push – a rise in production costs
– Inflationary Expectations – beliefs about
future price levels

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 Demand Pull
• AD increases faster
than productive
capacity (AS)
• Then firms will respond
by putting up prices –
to achieve better profit
margins.

“too much money chasing

too few goods” –
monetarist view

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 Cost Push

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 Expectations

• Individual’s perceptions of future price rises

• Inflation becomes self fulfilling

• Example: If individuals expect 3% inflation,

then they will seek increases in wages and
prices of 3% to maintain real prices and
wages

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Demand Pull and Cost Push Inflation

• https://www.tutor2u.net/economics/refer
ence/inflation-causes-of-inflation

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 Quick quizz

Define which type of inflation (Demand Pull / Cost

Push) arises in the following situations:
- An increase in real wage rates
- An increase in investments by firms
- An increase in government spending on health
services
- An increase in exports from Macedonia to the
rest of the world
- An increase in the price of oil

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 Deflation
• General level of prices declines
• Due to both demand and cost reasons
• Demand:
- If AD falls during a recession, then there is deflation
(GFC)
- If consumers postpone their spending expecting
price reductions
• Supply: If firms benefit from cost saving, they
increase supply and deflation occurs (China
exports)
• Fear of deflation – if fall in prices affects
wages (with financial commitments fixed)
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 Measuring Inflation
How the Consumer Price Index Is Calculated
• State Statistical Office – Consumer Price
Index (CPI)
• Step 1: Household budget survey to generate
common basket of goods and services of a
typical Macedonian household

• Step 2: Goods in the basket are weighted

• Step 3: Each month SSO collects information

on prices of those goods

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How the Consumer Price Index Is
Calculated
• Step 4: Compute the Basket’s Cost: Use the data
on prices to calculate the cost of the basket of goods
and services at different times.

• Step 5: Choose a Base Year and Compute the

Index:
– Designate one year as the base year, making it the
benchmark against which other years are
compared.
– Compute the CPI index by dividing the price of the
basket in one year by the price in the base year
and multiplying by 100
– This index is called CPI

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How the Consumer Price Index Is
Calculated
• Step 6: Compute the inflation rate:
The inflation rate is the percentage
change in the price index from the
preceding period.
• The Inflation Rate is calculated as
follows:
C P I in Y e a r 2 - C P I in Y e a r 1
I n f la tio n R a te in Y e a r 2 = 100
C P I in Y e a r 1

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Calculating the Consumer Price Index and the Inflation Rate:
An Example

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 Structure of Consumer Price Index RM (based on
Household budget survey to generate common basket of
goods and services)

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Consumer Price Index RM- January
2019 Т-01: Индекси на трошоците на животот според COICOP, јануари 2019 година
T-01: Consumer Price Index by COICOP, January 2019
I 2019 I 2019 I 2019 Ø 2018
--------- --------- --------- ----------  
  Ø 2018 XII 2018 I 2018 Ø 2017
0 ВКУПНО 100,2 99,9 101,2 101,5 TOTAL
01 Храна и безалкохолни 101,1 100,8 102,0 100,8 Food and non-alcoholic
пијалаци beverages
02 Алкохолни пијалаци, тутун и 101,7 100,0 104,8 105,5 Alcoholic beverages,
наркотици tobacco and narcotics
03 Облека и обувки 99,8 98,1 100,8 99,6 Clothing and footwear
04 Домување, вода, електрика, 100,3 100,0 100,2 100,0 Housing, water, electricity,
гас и други горива gas and other fuels

05 Мебел, покуќнина и 100,9 100,5 101,3 100,8 Furnishings, household

одржување на покуќнината equipment and routine
maintenance of the house

06 Здравје 102,5 100,9 102,9 100,7 Health

07 Транспорт 94,7 97,6 97,1 107,5 Transport
08 Комуникации 98,4 98,3 98,8 100,7 Communication
09 Рекреација и култура 101,2 100,2 102,6 102,4 Recreation and culture
10 Образование 99,5 99,5 99,5 99,9 Education
11 Ресторани и хотели 100,5 99,2 102,1 101,9 Restaurants and hotels
12   Останати стоки и услуги 100,4 99,9 101,1 100,5   Miscellaneous goods and
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How the Consumer Price Index Is
Calculated? Example
• Calculating the Consumer Price Index
and the Inflation Rate: Another
Example
– Base Year is 2002.
– Basket of goods in 2002 costs $1,200.
– The same basket in 2004 costs $1,236

Calculate the CPI and inflation

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How the Consumer Price Index Is
Calculated? Example
• Calculating the Consumer Price Index
and the Inflation Rate: Another Example
– Base Year is 2002.
– Basket of goods in 2002 costs $1,200.
– The same basket in 2004 costs $1,236.
– CPI = ($1,236/$1,200)  100 = 103.
– Prices increased 3 percent between 2002
and 2004.

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 Quick questions

• Which one has a higher effect on CPI: a

10% increase in the price of chicken or
10% increase in the price of caviar?

• Would the effect of increased price of

chicken on CPI be greater in Macedonia or
Germany?

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The GDP Deflator versus the
Consumer Price Index
• Economists and policymakers monitor both
the GDP deflator and the consumer price
index to gauge how quickly prices are rising.
• There are two important differences between
the indexes that can cause them to diverge.

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The GDP Deflator versus the
Consumer Price Index

GDP Deflator CPI Index

• reflects the prices of all • reflects the prices of all
goods and services goods and services
produced domestically bought by consumers.
• compares the price of • compares the price of a
currently produced goods fixed basket of goods
and services to the price and services to the price
of the same goods and of the basket in the base
services in the base year. year (only occasionally
the basket changes)...

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Inflation and GDP deflator in
Macedonia

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 Price Deflators

Nominal salary
Real salary = * 100
Price Index

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Nominal and real interest rates

• Inflation affects real interest rates

• Real interest rate = Nominal interest rate –
inflation rate

Example: Sally Saver deposits $1000 in a

bank account that pays annual interest of
10 percent. In one year time Sally has
accumulated 100$ in interest. Is Sally richer
now? (Discuss)

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Problems in measuring inflation

• CPI shows how much incomes should

rise in order to preserve the standard of
living
• It is not ideal measure:
- Substitution bias – consumers respond
to price changes
- Introduction of new goods – (new value
for consumers)
- Unmeasured quality changes

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 Indexation

• Automatic correction of nominal

values for the effects of inflation
• Usually applied to:
- Minimum wages
- Social security
- Pensions

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 Costs of Inflation

• illusionary – confusing nominal and real

changes (could affect consumption decisions)
• Menu costs – burden for firms
• Fiscal drag – in case of wage adjustment
• Redistribution of wealth (from lenders to
borrowers – structural change in patterns of
consumption)

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 Hyperinflation

• Def:   50% per month

• All the costs of moderate inflation described
above become HUGE under hyperinflation.
• Money ceases to function as a store of value,
and may not serve its other functions (unit of
account, medium of exchange).
• People may conduct transactions with barter
or a stable foreign currency.

slide 65
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 Why Target Inflation?
• Reduces uncertainty in the economy

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