Copyright 2000 Addison-Wesley Longman CHAPTER 2 The Measurement of Income, Prices, and Unemployment...

Copyright 2000 Addison-Wesley Longman

CHAPTER 2The Measurement of Income,Prices, and Unemployment

It has been said that figures rule the world; maybe.I am quite sure that it is figures which show us whether it is being ruled well of badly

-Johann Wolfgang Goethe, 1830

Flows and Stocks

• Investment and the Capital Stock:K = K-1 + I

– Capital stock = capital stock last year + investment

• Saving and WealthW = W-1 + S

• Current Account and net International Investment Position– net international investment position (NIIP)

measures the net stock of outstanding loans between a country and the rest of the world

NIIP = NIIP-1 + CA

• Public Debt and the DeficitDg = Dg

-1 + DEF

National Income Accounting

• Purpose: measure the flow of output; it measures the performance of the economy for purposes of public policy

• Created in the aftermath of the Great Depression, during WWII to determine the capacity of US industry to help fight the war


Gross Domestic Product

• GDP is the most important measure of economic output

• GDP is defined as the total value of all final goods and services produced by the domestic economy in one year

• Includes:– Currently produced goods and services

– Goods sold on the market

– Excludes goods that are resold in the current period

• Genuine Progress Indicator

http://www.rprogress.org/

GDP and GNP

• GNP=total value of all goods and services produced by the nation’s citizens

• GNP = GDP + NFP

• NFP (Net Foreign Product) = factor payments to domestic residents abroad minus factor payments to foreigners earned domestically

Measuring GDP

Output Approach:

GDP = C + I + G + NX

Value-added Approach:

GDP = Wages + Profits + Rents + Interest + Indirect Business Taxes


Figure 2-2 The Contribution of One Loaf of Bread to Consumption Expenditures and Income Created

Types of Expenditures

• Consumption ( C )– durable goods

– nondurable goods

– services

• Investment (I)– Inventory investment

– Fixed investment• producer goods

• new construction

• Government (G)– R = tax revenue

– F = transfer payments

– T = net taxes = R - F

• Net Exports (NX)– exports

– Imports


Flow in equations

• Y = C+S+T• E= C+I+G+(NX)• Y=E• C+S+T= C+I+G+

(NX)• S+T= I+G+(NX)

• Saving and taxes (income not consumed equals that part of expenditures that is not consumed

• Leakages=withdrawals from expenditures (income not consumed) S,T, IM

• Injections=expenditures not consumed) I,G, EX


Figure 2-3 Introduction of Saving and Investment to the Circular Flow Diagram


Figure 2-4 Introduction of Taxation, Government Spending, and the Foreign Sector to the Circular Flow Diagram

Consumption as a Percentage of GDP

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1930 35 40 45 50 55 60 65 70 75 80 85 90 95

Investment as a Percentage of GDP

0%

5%

10%

15%

20%

1930 35 40 45 50 55 60 65 70 75 80 85 90 95

Government Spending as a Percentage of GDP

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

1930 35 40 45 50 55 60 65 70 75 80 85 90 95

Exports and Importsas a Percentage of GDP

0%

2%

4%

6%

8%

10%

12%

14%

1930 35 40 45 50 55 60 65 70 75 80 85 90 95

Years

Imports Exports

Types of Income

• Compensation

• Corporate Profits

• Proprietor Profits

• Interest

• Rents

Employee Compensation as a Percentage of National Income

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

30 35 40 45 50 55 60 65 70 75 80 85 90 95

Years

Corporate Profits, Proprietorships, and Interest as a Percentage of National Income

-5%

0%

5%

10%

15%

20%

25%

30 35 40 45 50 55 60 65 70 75 80 85 90 95

Coporate Profits

Interest

Proprietorships

Other Measures of Economic Output

• Net national product (NNP) = GNP - depreciation

• National Income (NI) = NNP - indirect taxes + business transfer payments (gifts, etc)

• Personal Income (PI) = NI – - contributions to social insurance (FICA)– - corporate profits minus dividends– + personal interest income from the

government and consumers– + government transfer payments (e.g.,

unemployment insurance, relief, benefits to veterans)

• Disposable Income (Yd) = NI - personal taxes

GDP over time


Figure 2-5 Nominal GDP, Real GDP, and the Implicit GDP Deflactor, 1900-98


1987 1999

Apples 0.10$ 0.20$ Bananas 0.20$ 0.25$

Physical outputsApples 30 20Bananas 10 20

Apples 3.00$ 4.00$ Bananas 2.00$ 5.00$ Total: Nominal GDP 5.00$ 9.00$

Constant Dollar Expendituresat 87 prices 5.00$ 6.00$ P87*Q87 P87*Q99at 99 prices 8.50$ 9.00$ P99*Q87 P99*Q99

Expenditures each YearAt fixed 87 quantitites 5.00$ 8.50$ P87*Q87 P99*Q87At fixed 99 quantitites 6.00$ 9.00$ P87*Q99 P99*Q99

Real GDPAt 87 prices 1 1.2At 99 prices 1 1.058824Chain-weighted 1 1.13

GDP Deflatorat 87 quantities 1 1.7at 99 quantities 1 1.5

Chain-weighted 1 1.59

Prices

Nominal Expenditures


Figure 2-6 The U.S. Ratio of Actual to Natural Real GDP (Y/YN) and the Unemployment Rate, 1956-98


Relation Between Unemployment and the Business Cycle

• Okun’s law: for every 2 percent increase in GDP, unemployment falls by 1 percent


Unemployment Rate

0%

10%

20%

30%

1930 35 40 45 50 55 60 65 70 75 80 85 90 95

Unem

ploym

ent R

ate

Great Depression

WWII VietnamKorean War

Oil Embargo

Fed Induced Recession


Selected Unemployment Rates

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

197

0

197

2

197

4

197

6

197

8

198

0

198

2

198

4

198

6

198

8

199

019

9219

94

Japan

Germany

UK

Copyright 2000 Addison-Wesley Longman CHAPTER 2 The Measurement of Income, Prices, and Unemployment...

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