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to Accompany macroeconomics, 5th ed.

N. Gregory Mankiw

CHAPTER TWO
The Data of Macroeconomics

Mannig J. Simidian

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

The consumer price index (CPI) measures

the level of prices.

The unemployment rate tells us the fraction

of workers who are unemployed.

Chapter Two 2
 Income, Expenditure
And the Circular Flow
There are 2 ways Total income of everyone in the economy
of viewing GDP Total expenditure on the economys
output of goods and services
Income $
Labor
Households Firms
Goods

Expenditure $
For the economy as a whole, income must equal expenditure.
GDP measures the flow of dollars in this economy. 3
Chapter Two
1) To compute the total value of different goods and services, the
national income accounts use market prices.
Thus, if
$0.50 $1.00

GDP = (Price of apples Quantity of apples)

+ (Price of oranges Quantity of oranges)
= ($0.50 4) + ($1.00 3)
GDP = $5.00
2) Used goods are not included in the calculation of GDP.
3) The treatment of inventories depends on if the goods are stored or
if they spoil. If the goods are stored, their value is included in GDP.
If they spoil, GDP remains unchanged. When the goods are finally sold
out of inventory, they are considered used goods (and are not counted).
Chapter Two 4
4) Intermediate goods are not counted in GDP only the value of
final goods. Reason: the value of intermediate goods is already
included in the market price. Value added of a firm equals the
value of the firms output less the value of the intermediate goods
the firm purchases.

5) Some goods are not sold in the marketplace and therefore dont
have market prices. We must use their imputed value as an estimate
of their value. For example, home ownership and government services.

Chapter Two 5
The value of final goods and services measured at current prices is called
nominal GDP. It can change over time either because there is a change
in the amount (real value) of goods and services or a change in the prices
of those goods and services.
Hence, nominal GDP Y = P y, where P is the price level and y is real
output and remember we use output and GDP interchangeably.
Real GDP or, y = YP is the value of goods and services measured using
a constant set of prices.
This distinction between real and nominal can also be applied to other
monetary values, like wages. Nominal (or money) wages can be denoted
by W and decomposed into a real value (w) and a price variable (P).
Hence, W = nominal wage = P w
w = real wage = w/P
This conversion from nominal to real units allows us to eliminate the
problems created by having a measuring stick (dollar value) that
essentially changes length over time, as the price level changes. 6
Chapter Two
 Lets see how real GDP is computed in our apple and
orange economy.

For example, if we wanted to compare output in 2002 and output

in 2003, we would obtain base-year prices, such as 2002 prices.

Real GDP in 2002 would be:

(2002 Price of Apples 2002 Quantity of Apples) +
(2002 Price of Oranges 2002 Quantity of Oranges).
Real GDP in 2003 would be:
(2002 Price of Apples 2003 Quantity of Apples) +
(2002 Price of Oranges 2003 Quantity of Oranges).
Real GDP in 2004 would be:
(2002 Price of Apples 2004 Quantity of Apples) +
(2002 Price of Oranges 2004 Quantity of Oranges).
Chapter Two 7
 GDP Deflator = Nominal GDP
Real GDP

Nominal GDP measures the current dollar value of the output of

the economy.

Real GDP measures output valued at constant prices.

The GDP deflator, also called the implicit price deflator for GDP,
measures the price of output relative to its price in the base year. It
reflects whats happening to the overall level of prices in the economy.

Chapter Two 8
 In some cases, it is misleading to use base year prices that
prevailed 10 or 20 years ago (i.e. computers and
college). In 1995, the Bureau of Economic Analysis
decided to use chain-weighted measures of
real GDP. The base year changes continuously
over time. This new chain-weighted
Average prices in 2001 measure is better than the more
and 2002 are used to measure traditional measure because it
real growth from 2001 to 2002. ensures that prices will not be
Average prices in 2002 and 2003 too out of date.
are used to measure real growth from
2002 to 2003 and so on. These growth
rates are united to form a chain that is
used to compare output between any two
dates.Chapter Two 9
 Y
Y == CC ++ II ++ G
G ++ NX
NX
Totaldemand
Total demand Investment
Investment
fordomestic
for domestic isiscomposed
composed spendingby
spending by
output(GDP)
output (GDP) of
of businessesand
businesses and
households
households Netexports
Net exports
ornet
or netforeign
foreign
Consumption Government demand
demand
Consumption Government
spendingby
spending by purchasesof
purchases ofgoods
goods
households
households andservices
and services

This is the called the national income accounts identity.

Chapter Two 10
To see how the alternative measures of income relate to one
another, we start with GDP and add or subtract various quantities.
To obtain gross national product (GNP), we add 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

Whereas GDP measures the total income produced domestically, GNP

measures the total income earned by nationals (residents of a nation).

To obtain net national product (NNP), we subtract the depreciation of

capital-- the amount of the economys stock of plants, equipment, and
residential structures that wears out during the year:
Chapter Two
NNP = GNP - Depreciation 11
 The Consumer Price Index (CPI) turns the prices
of many goods and services into a single index
measuring the overall level of prices.

Chapter Two 12
 Lets see how the CPI would be computed in our
apple and orange economy.

For example, suppose that the typical consumer buys 5 apples and 2
oranges every month. Then the basket of goods consists of 5 apples
and 2 oranges, and the CPI is:

CPI= ( 5 Current Price of Apples) + (2 Current Price of Oranges)

( 5 2002 Price of Apples) + (2 2002 Price of Oranges)

In this CPI calculation, 2002 is the base year. The index tells how
much it costs to buy 5 apples and 2 oranges in the current year
relative to how much it cost to buy the same basket of fruit in 2002.
Chapter Two 13
The GDP deflator measures the prices of all goods produced, whereas
the CPI measures prices of only the goods and services bought by
consumers. Thus, an increase in the price of goods bought by firms or
the government will show up in the GDP deflator but not in the CPI.

Also, another difference is that the GDP deflator includes only those
goods and services produced domestically. Imported goods are not a
part of GDP and therefore dont show up in the GDP deflator.

The final difference is the way the two aggregate the prices in the
economy. The CPI assigns fixed weights to the prices of different
goods, whereas the GDP deflator assigns changing weights.

Chapter Two 14
The labor force is defined as the sum of the employed and
unemployed, and the unemployment rate is defined as the
percentage of the labor force that is unemployed.
The labor force participation rate is the percentage of the adult
population who are in the labor force.

Unemployment Rate = Number of Unemployed 100

Labor Force

Labor-Force Participation Rate = Labor Force 100

Adult Population

Chapter Two 15
The negative relationship between unemployment and GDP is called
Okuns Law, after Arthur Okun, the economist who first studied it.

In short, it is defined as:

Percentage Change in Real GDP =
3% - 2 the Change in the Unemployment Rate

If the unemployment rate remains the same, real GDP grows by

about 3 percent. For every percentage point the unemployment rate
rises, real GDP growth typically falls by 2 percent. Hence, if the
unemployment rate rises from 6 to 8 percent, then real GDP growth
would be:

Percentage Change in Real GDP = 3% - 2 (8% - 6%) = - 1%

Chapter Two 16
Gross domestic product (GDP) National income accounts identity
Consumer Price Index (CPI) Consumption
Unemployment Rate Investment
National income accounting Government Purchases
Stocks and flows Net Exports
Value added Labor force
Imputed value
Labor-force participation rate
Nominal versus
Okuns Law
real GDP GDP
deflator

Chapter Two 17