Measurement of main macro variables

Debajit Jha
Feb 23 and March 1, 2022

Jindal School of Government and Public Policy Lecture 04

O. P. Jindal Global University Fall 2022
 Reading
Macroeconomics
Authour: Oliver Blanchard
Edition: 7th (2017)
Publisher: Pearson

Chapter 2 (Pages 41 -63)

Macroeconomics 2
 What we will discuss?
• The words output, unemployment, and inflation
appear daily in newspapers and on the evening
news.

• In this chapter, we define these words more

precisely.

• The chapter also introduces concepts around

which the book is organized: the short run, the
medium ran, and the long run.
 National Income Account
• National income and product accounts were developed at the end of World War II
as measures of aggregate output.

• The measure of aggregate output is called gross domestic product (GDP).

• How would you define aggregate output in the economy?

Example
• Consider an economy with two firms, Firm 1 and Firm 2.
• Is aggregate output the sum of the values of all goods produced, i.e., $300? Or just
the value of cars, i.e., $200?
This provides the motivation for the first definition of GDP

Definition 1: GDP is the value of final goods and services produced in the economy during a given
period.

The important word here is final. We want to count only the production of final goods, not
intermediate goods

Example: If we merge the two firms in the previous example, the revenues of the new firm
equal $200.

This first definition gives us one way to construct GDP: by recording and
adding up the production of all final goods—and this is indeed roughly the
way actual GDP numbers are put together.

But it also suggests a second way of thinking about and constructing GDP.
 Definition 2: GDP Is the Sum of Value Added in the Economy during a Given Period.

– The term value added means value added by a firm in different stages of production i.e.
its production minus the value of the intermediate goods used in production.

– Example: In the two-firm example, the value added equals

$100 + $100 = $200.

• So far, we have looked at GDP from the production side.

• The other way of looking at GDP is from the income side.

Example: Steel Manufacturers value added = $100 = $80 (labor income) + $20 (capital income).
Car Manufacturers value added $100 = $70 (labor income) + $30 (capital income)
For whole economy, labor income = $150 and capital income = $50
Value added = labor income + capital income
$200 = $150 + $50.

• This motivates the third definition of GDP

Definition 3: GDP is the sum of incomes in the economy during
a given period.

– Aggregate production and aggregate income are always equal.

– From the income side, valued added in the two-firm example

is equal to the sum of labor income ($150) and capital or
profit income ($50), i.e., $200.
To summarize:
• we can define aggregate output or GDP in three different but equivalent
ways.
i) production side: GDP equals the value of the final goods and services
produced in the economy during a given period.
ii) production side: GDP is the sum of value added in the economy during a
given period.
iii) income side: GDP is the sum of incomes in the economy during a given
period.

Two lessons to remember:

i. GDP is the measure of aggregate output, which we can look at from the
production side (aggregate production), or the income side (aggregate
income); and

ii. Aggregate production and aggregate income are always equal.

 Nominal and Real GDP
• Nominal GDP: is the sum of the quantities of final goods produced
times their current price.

• Thus nominal GDP increases over time for two reasons:

– First, the production of most goods increases over time.
– Second, the price of most goods also increases over time.

• Real GDP:
If our goal is to measure production and its change over time, we need
to eliminate the effect of increasing prices on our measure of GDP.

• This is done by calculating real GDP

• Real GDP is the sum of the quantities of final goods times constant
(rather than current) prices.
• Example:

• Real GDP in 2008 (in 2009 dollars) = 10 cars x $24,000 per car = $240,000.
• Real GDP in 2009 (in 2009 dollars) = 12 cars x $24,000 per car = $288,000.
• Real GDP in 2010 (in 2009 dollars) = 13 cars x $24,000 per car = $312,000.

The problem when constructing real GDP in practice is that there is obviously
more than one final good.

Real GDP must be defined as a weighted average of the output of all final goods,
and this brings us to what the weights should be.

The relative prices of the goods would appear to be the natural weights. If one
good costs twice as much per unit as another, then that good should count for
twice as much as the other in the construction of real output.
 • Here, what you should know is that the measure of real GDP in the U.S. national income
accounts uses weights that reflect relative prices and which change over time.

• The measure is called real GDP in chained (2009) dollars.

Figure plots the evolution of both nominal GDP and real GDP since 1960. By construction,
the two are equal in 2009. The figure shows that real GDP in 2014 was about 5.1 times its
level of 1960
 Indian nominal and real GDP
Nominal GDP
250000

200000

150000
Rupees billion

100000

50000

0
5 1 5 5 59 63 6 7 71 75 7 9 83 8 7 91 95 9 9 03 15 1 9
5 0- 54- 58- 62- 66- 70- 74- 78- 82- 86- 90- 94- 98- 02- 6-07 0-11 14- 18-
19 19 1 9 1 9 19 1 9 19 19 1 9 19 1 9 1 9 19 2 0 2 0 0 20 1 2 0 20

Years
Real GDP
160000
140000
120000
100000
Rupees Billion

80000
60000
40000
20000
0
5 3 56 59 6 2 6 5 68 7 1 7 4 77 80 8 3 86 89 9 2 95 9 8 0 1 04 13 16 1 9
5 2- 55- 58- 61- 64- 67- 70- 73- 76- 79- 82- 85- 88- 91- 94- 97- 00- 03- 6-07 9-10 12- 15- 18-
19 1 9 1 9 19 19 1 9 19 19 1 9 1 9 19 1 9 19 19 1 9 19 20 2 0 2 0 0 20 0 2 0 2 0 20

Years

Source: Handbook of Statistics on Indian Economy: RBI (BY: 2011-12)

 Synonyms of nominal and real GDP
• The terms nominal GDP and real GDP each have many synonyms, and
you are likely to encounter them in your readings:

– Nominal GDP is also called dollar GDP or GDP in current dollars.

– Real GDP is also called: GDP in terms of goods, GDP in constant dollars, GDP
adjusted for inflation, or GDP in chained (2009) dollars or GDP in 2009 dollars
— if the year in which real GDP is set equal to nominal GDP is 2009, as is the
case in the United States at this time.

• In the chapters that follow, unless we indicate otherwise,

– GDP will refer to real GDP and Yt will denote real GDP in year t.

– Nominal GDP, and variables measured in current dollars, will be denoted by a

dollar sign in front of them—for example, $Yt for nominal GDP in year t.
 GDP vs GDP growth
• In assessing the performance of the economy from year to year, economists focus on
the rate of growth of real GDP, called GDP growth.

• Periods of positive GDP growth are called expansions. Periods of negative GDP growth
are called recessions.

• GDP growth in year t is constructed as (Yt - Yt - 1 )/ Yt - 1

and expressed as a percentage.

Since 1960, the U.S.

economy has gone
through a series of
expansions, interrupted
by short recessions. The
2008–2009 recession was
the most severe
recession in the period
from 1960 to 2014.

Source: Calculated using series GDPCA in Figure 2-1.

 Growth rate of real GDP in India

Growth rate of Real GDP at FC

12

10

4
Percent

0
- 5 4 - 5 7 - 6 0 - 6 3 - 6 6 - 6 9 - 7 2 - 7 5 -7 8 - 8 1 -8 4 - 8 7 - 9 0 - 9 3 - 9 6 - 9 9 - 0 2 -0 5 0 8 1 1 - 1 4 - 1 7 - 2 0
3 56 59 62 65 68 7 1 74 77 80 83 86 89 92 95 98 01 04 7- 0- 13 16 19
5-2
1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 1 9 2 0 2 0 2 0 0 2 01 2 0 2 0 2 0
-4

-6
Years

Source: Handbook of Statistics on Indian Economy: RBI (BY: 2011-12)

 The Unemployment Rate

• Employment (N) is the number of people who have a job.

• Unemployment (U) is the number of people who do not have a

job but are looking for one.

• The labor force (L) is the sum of employment and

unemployment: L = N + U

• The unemployment rate is the ratio of the number of people

who are unemployed to the number of people in the labor force:

Unemployment rate (u) = Unemployment (U)/ Labor force (L) =

U/L
 Measuring Unemployment
• To be classified as unemployed, a person must meet two conditions:
– he or she does not have a job, and
– he or she is looking for one;
this second condition is harder to assess.

• Most countries rely on large surveys of households to compute the

unemployment rate.

• The U.S. Current Population Survey (CPS) relies on interviews of 60,000

households every month. Do you know, how we calculate unemployment
rates???

• A person is unemployed if he or she does not have a job and has been looking
for a job in the last four weeks.

• Those who do not have a job and are not looking for one are counted as not in
the labor force.
• Note that only those looking for a job are counted as unemployed; those
who do not have a job and are not looking for one are counted as not in
the labour force.

• When unemployment is high, some of the unemployed give up looking

for a job and therefore are no longer counted as unemployed.

• These people are known as discouraged workers.

• The participation rate is the ratio of the labor force to the total
population of working age.

• Because of discourage workers, a higher unemployment rate is typically

associated with a lower participation rate.

• https://economictimes.indiatimes.com/jobs/50-indias-working-age-popul
ation-out-of-labour-force-says-report/printarticle/67830482.cms
• Why Do Economists Care about Unemployment?
– Direct effect on the welfare of the unemployed, especially those
remaining unemployed for long periods of time.
– A signal that the economy is not using its human resources efficiently.

• What about when unemployment is low? Can very low

unemployment also be a problem?

• Very low unemployment can also be a problem as the

economy runs into labor shortages.
 Unemployment rate in U.S

• Since 1960, the U.S. unemployment rate has fluctuated between 3 and 10%,
going down during expansions and going up during recessions.
 Unemployment rate in U.S

• Since 1960, the U.S. unemployment rate has fluctuated between 3 and 10%, going down
during expansions and going up during recessions.

• The effect of the recent crisis is highly visible, with the unemployment rate reaching
close to 10% in 2010, the highest such rate since the early 1980s.
India’s Unemployment rate (1991-2019)

Unemployment rate
5.8
5.7
5.6
5.5
percent

5.4
5.3
5.2
5.1
5
9 91 993 995 997 999 001 003 005 007 009 011 013 015 017 019
1 1 1 1 1 2 2 2 2 2 2 2 2 2 2
years

Source: World Bank national accounts data

 Unemployment rate in India

Source: World Bank Online Database, www.data.worldbank.org

 Unemployment and Happiness
Results of the German Socio-Economic Panel survey suggest that

(1) becoming unemployed leads to a large decrease in happiness,

(2) happiness declines before the actual unemployment spell, and

(3) happiness does not fully recover even four years later.
Effects of Unemployment on Happiness

Source: Winkelmann 2014.

 The Inflation Rate
• Inflation is a sustained rise in the general level of prices—the
price level.

• The inflation rate is the rate at which the price level increases.

• Deflation is a sustained decline in the price level (negative

inflation rate).
 The GDP Deflator
• The GDP deflator in year t (Pt) is the ratio of nominal GDP to real GDP in year t:

• It is called an index number (1 in 2009), which has no economic interpretation.

• Where it will be one for India???

• The rate of change has a clear interpretation: the rate of inflation.

πt = (Pt − Pt-1)/Pt-1

• Defining the price level as the GDP deflator implies a simple relation between nominal GDP, real GDP,
and the GDP deflator:
$Yt = PtYt

• Nominal GDP is equal to the GDP deflator times real GDP.

• The rate of growth of nominal GDP is equal to the rate of inflation plus the rate of growth of real GDP.
 The Consumer Price Index

• The GDP deflator gives the average price of output—the final goods produced
in the economy.

• But consumers care about the average price of consumption—the goods they
consume.

• The two prices need not be the same

• The set of goods produced in the economy is not the same as the set of goods
purchased by consumers, for two reasons:

– Some of the goods in GDP are sold not to consumers but to firms
(machine tools, for example), to the government, or to foreigners.

– Some of the goods bought by consumers are not produced domestically

but are imported from abroad.
 • The Consumer Price Index (CPI) is a measure of the cost of living.

• The CPI is published monthly by the Bureau of Labor Statistics (BLS), which
collects price data for 211 items in 38 cities.

• The CPI gives the cost in dollars of a specific list of goods and services over
time.
Inflation Rate, Using the CPI and the GDP Deflator, 1960–2014
The CPI and GDP deflator
moved together most of the
time.
Exception: In 1979 and
1980, the increase in the
CPI was significantly larger
than the increase in the
GDP deflator due to the
price of imported goods
increasing relative to the
price of domestically
produced goods.

The inflation rates, computed using either the CPI or the GDP deflator, are largely similar.
 India’s Inflation rate (1990-2019)
Inflation (annual %)
16
14
12
10
Percent

8
6
4
2
0
0 3 6 9 2 5 8 1 4 7
199 199 199 199 200 200 200 201 201 201
Years

Source: Handbook of Statistics on Indian Economy: RBI

 Inflation in 2021
50.0 16.0

14.0
40.0

12.0

30.0
10.0

20.0 8.0

6.0
10.0

4.0

0.0
Jan/21 Feb/21 Mar/21 Apr/21 May/21 Jun/21 Jul/21 Aug/21 Sep/21 Oct/21 Nov/21 Dec/21 2.0

-10.0 0.0

WPI_Primary commodities WPI_Fuel & power WPI_Manufactured products

CPI (right) WPI (right)

Source: Economic Outlook database, CMIE

Why Do Economists Care about Inflation?

– Inflation affects income distribution when not all prices and wages rise
proportionally.

– Inflation leads to distortions due to uncertainty, some prices that are fixed by law
or by regulation, and its interaction with taxation (bracket creep in taxes).

• Most economists believe the “best” rate of inflation to be a low and

stable rate of inflation between 1 and 4%.

• CPI and WPI in India

• https://www.thehindubusinessline.com/economy/wpi-inflation-dips-to-
108-in-july-with-sharp-fall-in-fuel-power-prices/article29094900.ece

• https://indianexpress.com/article/explained/wholesale-retail-inflation-c
oronavirus-impact-economy-7190282/
 The Short Run, the Medium Run, and the Long Run

• In the short run (e.g., a few years), year-to-year movements in

output are primarily driven by movements in demand.

• In the medium run (e.g., a decade), the economy tends to return to

the level of output determined by supply factors, such as the capital
stock, the level of technology, and the size of the labor force.

• In the long run (e.g., a few decades or more), the economy depends
on its ability to innovate and introduce new technologies, and how
much people save, the quality of the county’s education system, the
quality of the government, and so on.
 Data Exercise: 1
• Go to
https://www.rbi.org.in/Scripts/AnnualPublications.aspx?head=Handbook
%20of%20Statistics%20on%20Indian%20Economy
Data Exercise 2
Data Exercise 3