CH 23-24 Macro

Measuring a Nation’s Income
ECO110 Macroeconomics
Monsoon 2021
This is an open access resource distributed under the terms and conditions of the Creative Commons Attribution license
Important issues in Macroeconomics
Macroeconomics The study of the economy

as a whole, attempts to answer
 Why the cost of living continues to rise?
 Why is there unemployment?
 What causes recessions? Can the government do anything to combat
recessions? Should it?
 What is meant by government budget deficit? How does it affect the
economy?
 Why do some countries have such a large trade deficit?
 How much should the government spend on COVID-19 vaccine
research?
 Why are many countries poor? What policies can help them and grow out
of poverty?
This is anThis
openis an open resource
access access resource distributed
distributed under
under theterms
the terms and
andconditions
conditionsof the Creative
of the Commons
Creative Attribution
Commons license
Attribution
license
Gross Domestic Product:
Expenditure and income
3
Two definitions:
 Total expenditure on final goods and services produced in a
country.
 total revenue obtained by the production factors located in a
country.
Spending equals income because

every euro spent by a buyer means an
income for a seller.
The circular flow diagram
4
Income (€)
Work
homes Business
Goods
Expenditure(€)
This is anThis
distributed under
under theterms
the terms and
andconditions
of the Commons
Commons license
Attribution
license
Gross domestic product (GDP)
5
definition:
– Market value of all final goods and services
produced in a country during a given period
of time
This is anThis
distributed under
under theterms
the terms and
andconditions
of the Commons
Commons license
Attribution
license
Value added
6
definition:
The value added a company is the value of its
production less the value of intermediate goods
the company uses in that production process
Exercise
7
 A farmer grows a bushel of wheat and sells it to a

miller for € 1.00.
 The miller turns the wheat into flour and sells it to a
baker for 3.00 €.
 The baker uses the flour to make bread and sells it to
an engineer for 6.00 €.
 The engineer eats the bread.
Calculate and compare the value added

at each stage of production or GDP
Final goods, value added and GDP
8
GDP = value of final goods produced

= Sum of value added at every stage of production
The value of final goods already includes the value of
intermediate goods,
so including intermediate and final goods in GDP
would mean double counting.
Other indicators of income
9
Gross National Product (GNP)

Net National Product (NNP)
National Income
Personal income
Personal Income Available
10
Gross National Product (GNP) is the total income

received by the permanent residents of a country
(national).
Net National Product (NNP) is the total income of a
country's residents (GNP) minus losses from
depreciation.
Depreciation is the wear of the stock of equipment
and structures of the economy. In national accounts
it is called consumption of fixed capital
11
National income is the total income earned by residents

of a country in the production of goods and services.
It differs from NNP because it excludes indirect taxes
(such as VAT) and includes subsidies to businesses.
Personal income is income received by households and
businesses that are not corporations.
Unlike national income excludes earnings, which is
income that corporations have received but have not been
distributed among the owners as dividends.
It also includes the interest income received by
households and government transfers.
12
Personal disposable income is the income that

remains to households and businesses that are not
corporations after fulfilling their obligations to the
state.
It is equal to minus taxes on personal income and
certain non-tax personal income payments.
GDP components
 GDP distribution between different types of expenditure
Where C=consumption, I=investment, G= Government

Purchases, NX= net exports (exports - imports)
 The equation is an identity, that is, an equation is always
fulfilled by the way the variables are defined
This is an This
open is access
an openresource distributed
access resource under
distributed the
under theterms
terms and conditions
and conditions of the
of the Creative
Creative Commons
Commons Attribution
Attribution license
license
US data in 2009
This table shows total GDP for the U.S. economy in 2009 and the breakdown of GDP
among its four components. When reading this table, recall the identity
Y = C + I + G + NX.
This is an This
open is access
distributed the
under theterms
of the Creative
Creative Commons
Commons Attribution
Attribution license
license
Consumption (C)
15
 It includes:
definition: The value of all  durable goods
goods and services They last a long period
purchased by households, example automobile,
appliances
with the exception of  nondurable
purchases of new housing last shorter periods
eg food, clothing
 services
done for consumers
Example: laundry, travel,
flying
Investment (I)
16
definition: spending on capital equipment, inventories, and

structures, including new housing purchases by households
It includes:
 Investing in equipment
Purchase of new plant and equipment by businesses to
produce other goods and services.
 Investing in construction
Purchase of new housing by households and investors.
 Variation in stocks of companies or enterprises
Change in value of stocks of companies.
Investment versus Capital
17
Note: Investment is spending on new capital.

Example (Assuming no depreciation):
1/1/2006:
the economy has capital amounting to € 500,000
million
in 2006:
investment € = 60,000 million
1/1/2007:
the economy will have capital amounting €
560,000 million
Investment in US in 2005
Thousands
% Of GDP
of million $
Investment $ 2,105.00 16,9%
Equipment goods 1,329.80 10.6
Construction 756.30 6.1
Stock 18,90 0.2
This is an This
open is access
distributed the
under theterms
of the Creative
Creative Commons
Commons Attribution
Attribution license
license
Government Purchases (G)
19
Definition: expenditure of central government

and regional and local goods and services
G excludes transfers
(Eg unemployment insurance payments),
because they do not represent spending on
goods and services.
US government purchases in 2005
$ Trillion % Of GDP
State purchases $ 2362.90 18,9%
Federal 877.70 7.0
non Defense 290.60 2.3
Defense 587.10 4.7
State and local 1,485.20 11.9

This is an This
open is access
distributed the
under theterms
of the Creative
Creative Commons
Commons Attribution
Attribution license
license
Net exports:
NX = EX - IM
21
Definition: spending on foreign goods produced domestically (exports)
minus spending on foreign goods inland residents (imports)
US Net Exports, 1950-2006

200 2%
Percentage of GDP
0 0%
Billions of dollars
-200 -2%
-400 -4%
-600 -6%
-800 -8%
1950 1960 1970 1980 1990 2000
Black Line (Net Exports in billions of US dollars), Blue line (percentage of GDP)
Real versus nominal GDP
22
GDP is the value of all final goods and services

produced.
Nominal GDP production of goods and services
valued at current prices
Real GDP production of goods and services valued
at current prices (prices of a base year)
Important Links
Impact of imports on GDP

https://www.forbes.com/sites/bobmcteer/2013/05/05/the-role-of-foreign-trade-on-gdp/#39cb72b1ae3b
https://fredblog.stlouisfed.org/2018/09/do-imports-subtract-from-gdp/
How the stock market affects GDP

https://www.investopedia.com/ask/answers/033015/how-does-stock-market-affect-gross-domestic-product-gdp.asp
https://www.nytimes.com/2020/05/10/business/stock-market-economy-coronavirus.html
https://
www.investopedia.com/ask/answers/042215/how-does-performance-stock-market-affect-individual-businesses.asp
What is GDP vs. GNI

https://www.oecd-ilibrary.org/economics/gross-national-income/indicator/english_8a36773a-en
https://www.britannica.com/topic/gross-national-income
https://www.who.int/data/gho/indicator-metadata-registry/imr-details/94
https://economictimes.indiatimes.com/definition/net-national-income
https://www.thebalance.com/gross-national-income-4020738
Economic indicators in times of crises

Indian data on GNI and others
https://tradingeconomics.com/india/gross-national-product
https://tradingeconomics.com/india/indicators
https://data.oecd.org/gdp/quarterly-gdp.htm
https://indianexpress.com/article/business/economy/gdp-fourth-quarter-covid-19-lockdown-6433148/
https://www.stats.govt.nz/information-releases/gross-domestic-product-march-2020-quarter
Real GDP influenced by inflation
24
Changes in nominal GDP can be due to:

 price changes
 changes in the quantities produced.
Changes in real GDP only due to changes in

quantities, because real GDP is constructed using
constant prices of a base year.
problem
25
2006 2007 2008

P Q P Q P Q
Good A $ 30 900 $ 31 1000 $ 36 1,050
Good B $ 100 192 $ 102 200 $ 100 205
Calculate the nominal GDP in each year.

Compute real GDP in each year using 2006 as
base year.
answer
26
nominal GDP: multiply P and Q of the same year

2006: $ 46,200 = $ 30  900 + $ 100  192
2007: $ 51,400
2008: $ 58,300
Real GDP: Q multiply each year P 2006

2006: $ 46,200
2007: $ 50,000
2008: $ 52,000 = $ 30  1050 + $ 100  205
nominal and real GDP in the US
1950-2006
27
14.000
12.000
10.000
(billones)
8.000
6.000 Real GDP (in $

of 2000)
4.000
Nominal GDP
2.000
0
1950 1960 1970 1980 1990 2000
This is an This
open is access
distributed the
under theterms
of the Creative
Creative Commons
Commons Attribution
Attribution license
license
Brief points
28
Show GDP table with real and nominal GDP for India
Analysis of the current pandemic:
https://
economictimes.indiatimes.com/news/economy/indicators/india-gdp-to-shrink-by-
4-5-in-2020-due-to-covid-19-pandemic-dun-bradstreet-report/articleshow/774832
08.cms
https://
economictimes.indiatimes.com/news/economy/indicators/indian-economy-set-for-
post-covid-19-rebound-as-fdi-remains-buoyant-ihs-markit/articleshow/77127090.c
ms?from=mdr
https://www.statista.com/statistics/1103120/india-estimated-impact-on-gdp-growt
h-by-coronavirus-epidemic
/
This is an open access resource distributed under the terms and conditions of the Creative Commons Attribution
license
https://
The GDP deflator
29
One measure of the price level is

the GDP deflator, Which is defined as price level
indicator calculated by dividing nominal GDP by
real GDP and multiplying the result by 100
Inflation rate in year 2
Problem
30
nominal GDP
Real GDP Inflation rate
GDP deflator
2006 $ 46,200 $ 46,200 100.0 na
2007 51,400 50,000 102.8 2.8%
2008 58,300 52,000 112.1 9,1%
Real and Nominal GDP Table 2
31
This table shows

how to calculate
real GDP,
nominal GDP,
and the GDP
deflator for a
hypothetical
economy that
produces only
hot dogs and
hamburgers.
This is an open access resource distributed under the terms and conditions of the
Creative Commons Attribution license
license
GDP and economic welfare
 Is the GDP is the best indicator of economic well-

being of a society?
 GDP does not measure life expectancy, health of our children,
quality education in a country, entertainment value, value of a
clean environment and beauty of our poetry, our courage and
wisdom
 GDP does not include the distribution of income
 But all qualities are easier to promote (and also if a country wants to invest in
the best quality of public education) when the population is less busy in order
to cover the material necessities of life
license
International differences: GDP & quality of life
33
Rich countries - higher GDP per person

 Better
 Life expectancy
 Literacy
 Internet usage
Poor countries - lower GDP per person
 Worse
 Life expectancy
 Literacy
 Internet usage
GDP and the Quality of Life Table 3
34
The table shows GDP per person and three other measures of the quality of life for
twelve major countries.
This is anThis
open access resource distributed under the terms and conditions of the Creative Commons Attribution
is an open access resource distributed under the terms and conditions of the Creative Commons Attribution license
license
Appendix: Understanding the GDP deflator
35
Example 3 goods
For the good i = 1, 2, 3

Pit = Market price of good i in the month t
Qit = Amount of good i produced in the month t
NGDPt = Nominal GDP in month t
RGDPt = Real GDP in month t
Appendix: Understanding the GDP deflator
36
NGDPt P1t Q1t  P2t Q2t  P3t Q3t

GDP deflatort  
RGDPt RGDPt
 Q1t   Q2t   Q3t 

  P1t    P2t    P3t
 RGDPt   RGDPt   RGDPt 
The GDP deflator is a weighted average price.

the weight of each price reflects the relative importance
of each good in GDP.
Note that the weights change over time.
Appendix: two arithmetical tricks to
work with percentage
37
variations
one. For each variable X, Y,

percentage variation in (X  Y )
 percentage variation in X
+ percentage variation inY
Example: If your hourly wage increases 5%

and you work 7% more in terms of hours,
then your wage income increases
about 12%.
Appendix: two arithmetical tricks to
work with percentage variations
38
two percentage variation in (X/Y )

 percentage variation in X
 percentage variation in Y
Example: GDP deflator = 100  NGDP / RGDP.

If NGDP grows 9% and 4% rGDP grows,
then the rate of inflation is
approximately 5%.
Appendix: Chained real GDP Measures
39
Through time, relative prices change, so that the base
year should be updated periodically.
In essence, the Chained real GDP measurement
updates the base year every year, so it is most accurate
GDP at constant prices.
Measuring the Cost of Living
EPP110 MACROECONOMICS
MONSOON 2020
Consumer price index (CPI)
41
Definition: An indicator of the total cost of goods and

services purchased by a typical consumer
 Central Statistics Office, MoSPI (India), Bureau of Labor
Statistics (USA); FRED Database (St. Louis Fed)
The CPI is used to track the evolution of the cost of
living over time. When the CPI rises, the
representative family has to spend more to
maintain the same standard of living.
With CPI we can value that, how much must
incomes increase to maintain constant
purchasing power.
CPI Calculation
42
Fix the basket: the first is to find out what prices are
most important to the typical consumer, i.e., what are the
goods most purchased
The statistical offices in a country establish these
weights (importance) surveying a sample of consumers
(and establishments) and finding the basket of goods and
services purchased by the typical consumer. The goods
are classified into different groups (housing, food,
transportation, etc.)
Prices: collect the prices of each of the goods and
services that are part of the basket at each point in time.
CPI Calculation
43
the cost of the basket is calculated: Knowing

the composition of the basket and the prices of
goods, the cost of the basket for different moments of
time is calculated.
 prices are used each year, keeping the basket constant; the only
thing that varies is the price of goods and services. This is done
to isolate the effect of price changes from the effect of any
changes in quantities of goods.
CPI Calculation
44
A base year is chosen and the CPI is

calculated
the inflation rate is calculated

 Inflation rate: percentage change in the price index with
respect to the previous period
Inflation rate in year 2
CPI for India and USA
45
Show Excel sheet for Rural and Urban CPI for Feb 2019
Data sources for India
 Various categories of CPI
 Index of Industrial Production (IIP)
 http://www.mospi.gov.in/
 Check press releases and “search”
 http://www.mospi.gov.in/112-national-consumer-price-index-numbers
 http://labourbureau.gov.in/LBO_Press_Release.htm
 https://fred.stlouisfed.org/tags/series?t=cpi%3Bindia
Data sources for USA
https://fred.stlouisfed.org/tags/series?t=cpi%3Busa
https://www.bls.gov
Other unofficial sources such as Trading Economics and Statista
Exercise: Calculate the CPI
46
Basket contains 20 pizzas and 10 CDs.
Prices: Calculated for each year:

pizza CDs  The cost of the basket
2002 $ 10 $ 15  The CPI (use 2002 as
2003 $ 11 $ 15 the base year)
2004 $ 12 $ 16  Inflation rate with
2005 $ 13 $ 15 respect to the previous
year
Answers:
47
Cost CPI inflation

basket
2002 $ 350 100.0 na
2003 370 105.7 5.7%
2004 400 114.3 8.1%
2005 410 117.1 2.5%
Calculating the Consumer Price Index and the Inflation Rate: An
Example Table 1
48
This table shows how to calculate the consumer price index and the inflation rate for a
hypothetical economy in which consumers buy only hot dogs and hamburgers.
Calculating the Consumer Price Index and the Inflation Rate: An
Example Table 1
49
This table shows how to calculate the consumer price index and the inflation rate for a
hypothetical economy in which consumers buy only hot dogs and hamburgers.
The Typical Basket of Goods and Services
Figure 1
50
This figure shows how

the typical consumer
divides spending
among various
categories of goods
and services. The
Bureau of Labor
Statistics calls each
percentage the “relative
importance” of the
category.
This is anThis
open access
is an resource
open access distributed
resource under
distributed underthe
the terms andconditions
terms and conditions ofCreative
of the the Creative Commons
Commons Attribution
Attribution license
license
Reasons why the CPI may
overestimating inflation
51
Substitution bias: The CPI uses fixed weights, so it

does not reflect the ability of consumers to replace goods
whose relative prices have risen.
Introduction of new goods: The Introduction of new
goods enhances consumer welfare and, in effect,
increases the real monetary value. But it does not reduce
the CPI because the CPI uses fixed weights.
Unmeasured quality changes:
Quality increases increase the monetary value, but this is
usually only measured partly.
The size of bias in CPI
52
In 1995, a group of experts hired by the US Senate

estimated that the CPI overstates inflation by about
1.1% year.
The BLS then made adjustments to reduce bias.
Now the CPI bias is probably less than 1% per year.
CPI vs. GDP deflator
53
GDP deflator
 Compares the price of currently produced goods and
services
 To the price of the same goods and services in the base year
CPI
 Compares price of a fixed basket of goods and services
 To the price of the basket in the base year
CPI vs. GDP deflator
54
The price of capital goods

 Included in the GDP deflator (if produced domestically)
 Excluded from the CPI
Prices of imported consumer goods
 Included in the CPI
 Excluded in the GDP deflator
The basket of goods
 CPI: Fixed
 GDP Deflator: changes every year
Two Measures of Inflation
Figure 2
55
This figure shows the inflation rate—the percentage change in the level of prices— as
measured by the GDP deflator and the consumer price index using annual data since 1965.
Notice that the two measures of inflation generally move together.
Correcting Economic Variables
56
Dollar figures from different times

 Amount in today’s dollars =
 Amount in year T dollars x (Price level today/Price level in year T)
Indexation
 Automatic correction by law or contract
 Of a dollar amount
 For the effects of inflation
 COLA
 Cost of living allowance
Real and Nominal Interest Rates
57
Nominal interest rate

 Interest rate as usually reported
 Without a correction for the effects of inflation
Real interest rate
 Interest rate corrected for the effects of inflation
= Nominal interest rate – Inflation rate
What happens to your deposit of money (in a bank) after
a year? Earn more or earn less?
 Book example
 Increasing rent
Real and Nominal Interest Rates
Figure 3
58
This figure shows nominal and real interest rates using annual data since 1965. The nominal
interest rate is the rate on a 3-month Treasury bill. The real interest rate is the nominal interest
rate minus the inflation rate as measured by the consumer price index. Notice that nominal and
real interest rates often do not move together.
Real and Nominal Interest Rates in India
59
https://www.rbi.org.in/scripts/AnnualReportPublications.aspx?Id=93
https://dbie.rbi.org.in/DBIE/dbie.rbi?site=home
https://
dbie.rbi.org.in/BOE/OpenDocument/1608101729/OpenDocument/opendoc/open
Document.faces?logonSuccessful=true&shareId=1
https://data.worldbank.org/indicator/FR.INR.RINR?locations=IN
https://www.indexmundi.com/facts/india/indicator/FR.INR.RINR
Article
https://link.springer.com/article/10.1007/s40953-017-0079-2
license
Appendix: Understanding the CPI
60
Example 3 goods
For goods i = 1, 2, 3
Ci = Amount of good i in the CPI basket
Pit = Price of good i in the month t

Et = Cost of the CPI basket in month t
Eb = Cost of the basket in the base period
Appendix: Understanding the CPI
61
Et P1t C1 + P2t C2 + P3t C3

CPI in month t  
Eb Eb
 C1   C2   C3 
   P1t    P2t    P3t
 Eb   Eb   Eb 
CPI is a weighted average price.

the weight in each period reflects the relative importance
of each good in the CPI basket.
Note that the weights are constant over time.

CH 23-24 Macro

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH 23-24 Macro

Uploaded by

Copyright:

Available Formats

Measuring a Nation’s Income

Macroeconomics The study of the economy

Spending equals income because

 A farmer grows a bushel of wheat and sells it to a

Calculate and compare the value added

GDP = value of final goods produced

Gross National Product (GNP)

Gross National Product (GNP) is the total income

National income is the total income earned by residents

Personal disposable income is the income that

 GDP distribution between different types of expenditure

Where C=consumption, I=investment, G= Government

definition: spending on capital equipment, inventories, and

Note: Investment is spending on new capital.

Equipment goods 1,329.80 10.6

Construction 756.30 6.1

Stock 18,90 0.2

Definition: expenditure of central government

State purchases $ 2362.90 18,9%

Federal 877.70 7.0

non Defense 290.60 2.3

Defense 587.10 4.7

State and local 1,485.20 11.9

US Net Exports, 1950-2006

GDP is the value of all final goods and services

Impact of imports on GDP

How the stock market affects GDP

What is GDP vs. GNI

Economic indicators in times of crises

Changes in nominal GDP can be due to:

 changes in the quantities produced.

Changes in real GDP only due to changes in

2006 2007 2008

Good A $ 30 900 $ 31 1000 $ 36 1,050

Good B $ 100 192 $ 102 200 $ 100 205

Calculate the nominal GDP in each year.

nominal GDP: multiply P and Q of the same year

Real GDP: Q multiply each year P 2006

6.000 Real GDP (in $

Analysis of the current pandemic:

One measure of the price level is

Inflation rate in year 2

2006 $ 46,200 $ 46,200 100.0 na

2007 51,400 50,000 102.8 2.8%

2008 58,300 52,000 112.1 9,1%

This table shows

 Is the GDP is the best indicator of economic well-

Rich countries - higher GDP per person

For the good i = 1, 2, 3

NGDPt P1t Q1t  P2t Q2t  P3t Q3t

 Q1t   Q2t   Q3t 

The GDP deflator is a weighted average price.

one. For each variable X, Y,

Example: If your hourly wage increases 5%

two percentage variation in (X/Y )

Example: GDP deflator = 100  NGDP / RGDP.

Definition: An indicator of the total cost of goods and

the cost of the basket is calculated: Knowing

A base year is chosen and the CPI is

the inflation rate is calculated

Prices: Calculated for each year:

Cost CPI inflation