Measurement

Chapter 2

Topics in Macroeconomics 2
Economics Division
University of Southampton

February 2010

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

Gross Domestic Product

Gross Domestic Product (GDP)
Dollar value of final output produced during a given period of
time within the borders of a country

(Log) Real GDP Per Capita (year 2008 pounds)

4.4

Log RGDP per capita

4.3
4.2
4.1
4.0
3.9
3.8
3.7
3.6

19
00
19
06
19
12
19
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24
19
30
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36
19
42
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48
19
54
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60
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66
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78
19
84
19
90
19
96
20
02

3.5

Year

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

Approaches to Measure GDP

Product approach
Sum of value added to goods and services in production
across all productive units in the economy

Expenditure approach
Adds all spending on goods and services in the economy

Income approach
Adds up all incomes received by economic agents
contributing to production

NOTE: All three measures must add up to the same value

(up to measurement error of course)

Chapter 2

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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

A Simple Economy
Consider an economy composed of the following agents:
A corn producer
Uses labour to produce corn

A pig producer
Uses corn and labour to grow pigs

Consumers

A government

Supply labour, consume corn and pigs, provide loans

Taxes firms and workers, uses labour to produce
government supplied goods or services

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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

Producer 1
Corn Producer
Total revenue
Wages
interest on loans
Taxes

20 million
5 million
0.5 million
1.5 million

Produces 10 million bushels of corn which are sold for 2

per bushel
From these 6 million bushels are sold to the pig producer
and 4 million to consumers
Pays wages of 5 million to workers (who are the
consumers)
Pays 0.5 million in interest on a loan (to some consumers)
Pays 1.5 million in taxes to the government
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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

Producer 2
Pig Producer
Total revenue
Cost of feed corn
Wages
Taxes

30 million
12 million
4 million
3 million

Buys 6 million bushels of corn from the corn producer at 2

per bushelThese are intermediate goods

Pays wages of 4 million to workers

Pays 3 million in taxes to the government

Sells all its production to consumers (20 million kg at 1.50

per kilo)
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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

Producers: After-Tax Profits

After-Tax Profits
Corn producer
Pig producer

13 million
11 million

Total

24 million

After-Tax Profits = Total revenue

- Wages
- Interest
- Cost of intermediate inputs
- Taxes
Before-Tax Profits = 24 + 4.5 = 28.5 million
Chapter 2

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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

The Government
Government
Tax revenue
From producers
From consumers
Wages

4.5 million
1 million
5.5 million

The Government collects taxes from consumers and

producers

Uses the tax revenue to pay government workers (some

consumers) to build a bridge

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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

Consumers / Workers
Consumers
Wage income
Interest income
Taxes
Profits distributed by
producers

14.5 million
0.5 million
1 million
24 million

Consumers work for the producers and government,

earning a total of 14.5 million in wages
Receive 0.5 million in interest from the corn producer

Pay 1 million in taxes to the government

Receive after-tax profits of 24 million from producers

(consumers own the production units)

Chapter 2

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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

GDP Using the Product or Value Added Approach

GDP Using the Product Approach
Value addedcorn
Value addedpigs
Value addedgovernment
GDP

20 million
18 million
5.5 million
43.5 million

GDP is the sum of value added to goods and services in

production across all productive units in the economy
We need to subtract intermediate goods to avoid double
counting
Value added for the government is problematic: usually set
to the cost of the inputs since we dont have market prices
for most goods produced by the government
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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

GDP Using the Expenditure Approach

GDP Using the Expenditure Approach
Consumption (C)
Investment (I)
Government expenditures (G)
Net exports (NX )
GDP

38 million
0
5.5 million
0
43.5 million

GDP = Total Expenditures = C + I + G + NX

Consumers spend all their income (8 million on corn and

30 million on pigs)
The government spends all its income
There is no investment nor international trade in this
example
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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

GDP Using the Income Approach

GDP Using the Income Approach
Wage income
Before-tax profits
Interest income
GDP

14.5 million
28.5 million
0.5 million
43.5 million

GDP = Total Income = Y = C + I + G + NX

GDP is also the sum of all incomes received by economic

agents contributing to production

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

Gross National Product (GNP)

Gross National Product (GNP)
Pound value of final output produced by domestic factors of
production, regardless of where production takes place

Net Factor Payments

Income paid to domestic factors of production by the rest of the
world - Income paid to foreign factors of production by the
domestic economy
GNP = GDP + Net Factor Payments

Chapter 2

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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Introduction
An Example

Problems with Measures of GDP

Problems and things that are left out of GDP measures

Inequality

Non-market activity (home production)

Underground economy

Problems with value-added of the government and service

sector

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Nominal vs Real GDP

Nominal GDP

Real GDP at constant prices (base-year prices)

Measures GDP in the current year in terms of current prices

Measures GDP in the current year in terms of prices of a
base year
One problem with this measure is that the base year used
matters

Chain-weighted Real GDP

Essentially uses a rolling base year (eg. average price of

two consecutive years)

Chapter 2

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Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Data for the Example

Quantities and Prices
2007
Quantity
Price

Apples
50
1.00

Oranges
100
0.80

2008
Apples
80
1.25

Oranges
120
1.60

2009
Apples
100
2.00

Oranges
160
2.00

Nominal GDP in 2007: 50*1.00 + 100*0.80 = 130

Nominal GDP in 2008: 80*1.25 + 120*1.60 = 292

Nominal GDP in 2009: 100*2.00 + 160*2.00 = 520

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Nominal GDP and GDP Growth

Nominal GDP and GDP Growth

Nominal GDP ()
GDP growth (%)

2007

2008

2009

130

292
124.6

520
78.1

GDP Growth from 2007 to 2008 = 292/130 - 1

GDP Growth from 2008 to 2009 = 520/292 - 1

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Real GDP at Constant Prices: Base-Year = 2007

Quantities and Prices
2007
Quantity
Price

Apples
50
1.00

Oranges
100
0.80

2008
Apples
80
1.25

Oranges
120
1.60

2009
Apples
100
2.00

Oranges
160
2.00

Real GDP in 2007 (this is nominal GDP from before): 130

Real GDP in 2008: 80*1.00 + 120*0.80 = 176 (these

are 2007 )

Real GDP in 2009: 100*1.00 + 160*0.80 = 228

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Real GDP at Constant Prices: Base-Year = 2008

Quantities and Prices
2007
Quantity
Price

Apples
50
1.00

Oranges
100
0.80

2008
Apples
80
1.25

Oranges
120
1.60

2009
Apples
100
2.00

Oranges
160
2.00

Real GDP in 2007: 50*1.25 + 100*1.60 = 222.5 (these

are 2008 )

Real GDP in 2008 (this is nominal GDP from before): 292

Real GDP in 2009: 100*1.25 + 160*1.60 = 381

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Real GDP at Constant Prices: Base-Year = 2009

Quantities and Prices
2007
Quantity
Price

Apples
50
1.00

Oranges
100
0.80

2008
Apples
80
1.25

Oranges
120
1.60

2009
Apples
100
2.00

Oranges
160
2.00

Real GDP in 2007: 50*2.00 + 100*2.00 = 300 (these

are 2009 )

Real GDP in 2008: 80*2.00 + 120*2.00 = 400

Real GDP in 2009 (this is nominal GDP from before): 520

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Real GDP at Base-Year Prices

Real GDP at Base-Year Prices
2007

2008

2009

Base Year = 2007

Real GDP ()
Real GDP growth (%)

130

176
35.4

228
29.5

Base Year = 2008

Real GDP ()
Real GDP growth (%)

222.5

292
31.2

381
30.5

Base Year = 2009

Real GDP ()
Real GDP growth (%)

300

400
33.3

520
30.0

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Chain-Weighted Real GDP: Average Prices

Quantities and Prices
2007
Quantity
Price

Apples
50
1.00

Oranges
100
0.80

2008
Apples
80
1.25

Oranges
120
1.60

Average prices from 2007 to 2008:

Apples: 1.125
Oranges: 1.20

Average prices from 2008 to 2009:

Apples: 1.625
Oranges: 1.80
Chapter 2

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Topics in Macroeconomics

2009
Apples
100
2.00

Oranges
160
2.00

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Chain-Weighted Real GDP

Quantities and Prices
2007
Quantity
Avg Price

Apples
50

Oranges
100

2008
Apples
80
1.125

Oranges
120
1.20

Real GDP using 20072008 rolling prices:

2007: 50*1.125 + 100*1.20 = 176.25
2008: 80*1.125 + 120*1.20 = 234.00

Real GDP growth from 2007 to 2008: 32.8%

Real GDP growth from 2008 to 2009: 30.2%

Chapter 2

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Topics in Macroeconomics

2009
Apples
100
1.625

Oranges
160
1.80

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Chain-Weighted Real GDP at 2007 Constant Prices

Chain-Weighted Real GDP

Real GDP ()
GDP growth (%)

2007

2008

2009

130

172.64
32.8

224.78
30.2

2007: 130 (this is Real GDP in 2007 pounds)

2008: 130*(1 + 32.8%) = 172.64

2009: 172.64*(1 + 30.2%) = 224.78

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Nominal and Real (Chain-Weighted) GDP [Canada]

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Chain-Weighted Real GDP: Average Growth Rates

Real GDP Growth at Base-Year Prices
Base Year = 2007

Real GDP growth (%)

2007-2008
35.4

Base Year = 2008

Real GDP growth (%)

31.2

30.5

Base Year = 2009

Real GDP growth (%)

33.3

30.0

Average growth rate from 2007 to 2008:

gc20072008 =

1.354 1.312 = 1.3333

Average growth rates

from 2008 to 2009:

gc20082009 =

Chapter 2

1.305 1.30 = 1.302

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Topics in Macroeconomics

2008-2009
29.5

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Chain-Weighted Real GDP at 2007 Constant Prices

Chain-Weighted Real GDP

Real GDP ()
GDP growth (%)

2007

2008

2009

130.00

173.29
33.3

225.62
30.2

2007: 130.00 (this is Real GDP using 2007 prices)

2008: 130.00*(1 + 33.3%) = 173.29

2009: 173.29*(1 + 30.2%) = 225.62

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Nominal and Real (Chain-Weighted) GDP [U.K.]

4.4

Log RGDP per capita

4.3
4.2
4.1
4.0
3.9
3.8
3.7
3.6

19
00
19
06
19
12
19
18
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24
19
30
19
36
19
42
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48
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54
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19
66
19
72
19
78
19
84
19
90
19
96
20
02

3.5

Year

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Implicit GDP Price Deflator

Implicit GDP Price Deflator =

Nominal GDP
100
Real GDP

By convention, the price deflator is 100 in the base year (if

there is a base year)

Of course, the implicit GDP price deflator depends on the

measure of real GDP

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Implicit GDP Price Deflator

Implicit GDP Price Deflator
2007
100

2008
165.9
65.9

2009
228.1
37.5

Base Year = 2008

% increase

58.4

100
71.2

136.5
36.5

Base Year = 2009

% increase

43.3

73.0
68.5

100
37.0

Chain-weighted
% increase

100

169.1
69.1

232.1
37.2

Base Year = 2007

% increase

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Consumer Price Index (CPI): Base-Year = 2007

Quantities and Prices
2007
Quantity
Price

Apples
50
1.00

Oranges
100
0.80

2008
Apples
80
1.25

Oranges
120
1.60

2009
Apples
100
2.00

Oranges
160
2.00

CPI in 2007: 100

CPI in 2008: 100*(50*1.25 + 100*1.60)/130 = 171.2

(71.2% increase from 2007)

CPI in 2009: 100*(50*2.00 + 100*2.00)/130 = 230.8

(34.8% increase from 2008)

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Inflation from CPI and Implicit GDP Price Deflator

Inflation
Base Year = 2007

2008
65.9

2009
37.5

Base Year = 2008

71.2

36.5

Base Year = 2009

68.5

37.0

Chain-weighted

69.1

36.8

CPI

71.2

34.8

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Figure 2.3:
Inflation from CPI and Implicit GDP Deflator

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Nominal and Real GDP

An Example
Price Indices

Problems measuring Real GDP and the Price Level

Relative prices change over time

The quality of goods changes over time

New goods appear all the time

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Topics in Macroeconomics

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Measuring Real GDP
Other Measurement Issues

Savings, Wealth, and Capital

Labour Market Measurement

Some Definitions

Private disposable income Y d

Y d = Y + NFP + TR + INT T
TR: Transfers from the government to the private sector
INT : Interest on government debt
T : Taxes

Private sector saving S p

S p = Y d C = Y + NFP + TR + INT T C

Government saving S g
S g = T TR INT G

National saving S
S = S p + S g = Y + NFP C G
S = C + I + G + NX + NFP C G = I + NX + NFP = I + CA
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Measuring Real GDP
Other Measurement Issues

Savings, Wealth, and Capital

Labour Market Measurement

Nations Wealth

The set of assets held by the country as a whole

Plants, equipment, and structures

Housing (and durables?)

Wealth can be accumulated in 2 ways (S = I + CA)

Through investment, as addition to the nations capital stock

Through current account surpluses, as Brits accumulate
claims on foreigners

Wealth and capital are stocks

Investment and current account are flows

Chapter 2

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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Savings, Wealth, and Capital

Labour Market Measurement

Labour Market Measurement

Individuals can be in one of three labour market pools

Employed
Worked full-time or part-time during the last week

Unemployed
Not employed during the last week but
actively searched for work during the last 4 weeks

Out of the labour force

Neither employed nor unemployed
Unemployment rate =
Participation rate =

Chapter 2

Number unemployed
Labour force

Labour force
Total working age population
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Topics in Macroeconomics

Measuring GDP
Measuring Real GDP
Other Measurement Issues

Savings, Wealth, and Capital

Labour Market Measurement

Labour Market Tightness

Unemployment rate is potentially useful as a measure of

market tightness - degree of difficulty firms face in hiring
workers
But there are two potential problems:

Discouraged workers
Search intensity

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