Chapter 2

Measuring
Macroeconomic
Data
 Measuring Economic Activity:
National Income Accounting (cont’d)

• National income accounting is an

accounting system that measures economic
activity and its components
• Fundamental identity of national
income accounting:

Total Production = Total Expenditure = Total Income

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 TABLE 2.2 INCOME APPROACH TO
GDP, 2012

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 Real Versus Nominal GDP

• A nominal variable is a measure at

current market (nominal) prices (e.g.,
nominal GDP)
• A real variable is a measure in terms of
quantities of actual goods and services
(e.g., real GDP)

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 Real Versus Nominal GDP
(cont’d)

Nominal GDP
Real GDP =
Price Level
or

Nominal GDP = Price Level ✕ Real GDP

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 Measuring Inflation

• Price indexes are measures of the price

level
• Examples:
– GDP deflator (or implicit price deflator)
– Personal consumption expenditure deflator
– Consumer price index

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 GDP Deflator

GDP Deflator for Year y

Nominal GDP in Year y
= 100 x
Real GDP in Year y

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 PCE Deflator

PCE Deflator for Year y

Nominal PCE in Year y
= 100 x
Real PCE in Year y

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 Consumer Price Index

• A measure of the average prices of

consumer goods and services, i.e., a cost of
living index
• Calculated monthly by the Bureau of Labor
Statistics using a basket of thousands of
consumer goods and services

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 Consumer Price Index

• If the basket consists of 10 gallons of gas

and 2 apples, then the CPI for 2014 with a
base year of 2005 is:

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 Policy and Practice: Policy and
Overstatements of the Cost of Living

• The CPI is used in determining labor

contracts and government payments such
as Social Security benefits
• A study led by Michael Boskin of Stanford
University found that increases in the CPI
overstate increases in the cost of living by
1% point
• Measurements errors in the CPI could have
important implications

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 Inflation Rate

• The inflation rate is the % rate of change of

the price level over a particular period:

Pt - Pt 1 Pt
t = =
Pt 1 Pt 1
where

t = inflation rate in period t

Pt = period level at time t

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 FIGURE 2.4 U.S. Inflation Rates with
Different Price Indexes, 1950-2013

Source: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/

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 Percentage Change Method and the
Inflation Rate

• Because:

% Change in (x X y ) = (% Change in x)
+ (% Change in y )

• We know that:

% Change in No min al GDP =

(% Change in the Price Level)
+ (% Change in Real GDP)

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 Percentage Change Method and the
Inflation Rate (cont’d)

• Because the % change in the price level is

the inflation rate, while the % changes in
nominal and real GDP are the growth rate:

Inflation Rate = (Growth Rate of Nominal GDP)

- (Growth Rate of Real GDP)

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 Measuring Unemployment

• The unemployment rate is the percentage of

people in the civilian population who want to
work but who do not have jobs
• The Bureau of Labor Statistics classifies each
adult over age 16 into:
1. Employed
2. Unemployed
3. Not in the labor force
• Discouraged workers (those who would live to work
but have given up looking, and those who have
voluntarily left the labor force)

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 Measuring Unemployment
(cont’d)

Labor Force =
Number of Employed + Number of Unemployed

Number of Unemployed
Unemployment Rate =
Number of Employed

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 Measuring Unemployment
(cont’d)

Labor Force
Labor-Force Participation Rate =
Adult Population

Employed
Employment Ratio =
Adult Population

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 FIGURE 2.5 Unemployment in the
Adult Civilian Population, 2013

Source: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/

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 Macroeconomics In The News:
Unemployment and Employment

• The Bureau of Labor Statistics reports

employment and unemployment data using two
alternative surveys: the household survey and
the survey of business establishments
• The two surveys sometimes give a different
picture of labor market conditions due to:
• The household survey counts workers, while the
establishment survey counts jobs
• The household survey counts the self-employed as
working, while the establishment does not
• The establishment survey covers more workers

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 Measuring Interest Rates

• An interest rate is the cost of borrowing,

or the price paid for the rental of funds
• Interest rates are returns for holding debt
securities, such as bonds

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 Macroeconomics In The News:
Interest Rates

• Interest rates that receive media attention

are:
– Prime rate
– Federal funds rate
– London Inter-Bank Offered Rate (LIBOR)
– Treasury bill rate.
– Ten-year Treasury bond rate
– Federal Home Loan Mortgage Corporation rate

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 Real Versus Nominal Interest Rates

• A nominal interest rate makes no

allowance for inflation
• The real interest rate is the amount of
extra purchasing power a lender must be
paid for the rental of his/her money
– The ex ante real interest rate is adjusted
for expected changes in the price level
– The ex post real interest rate is adjusted
for actual changes in the price level

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 Real Versus Nominal Interest Rates
(cont’d)

• The Fisher equation:

i = nominal interest rate
r = nominal interest rate
pe = expected inflation

i = r + pe
e
or r =i-p

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 Real Versus Nominal Interest Rates
(cont’d)

• Example: For a one-year loan with a 4%

nominal interest rate (i=4%) and you expect
the inflation to be 6% in a year ( e=6%),
then:

r = 4% - 6% = -2%

• When the real interest rate is low, there are

greater incentives to borrow and invest, but
fewer incentives to lend.

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 The Important Distinction Between
Real and Nominal Interest Rates

• Credit markets are where households and

businesses get funds (credit) from each
other
• Because the real interest rate reflects the
real cost of borrowing, it is likely to be a
better indicator of the incentives to borrow,
invest, and lend in credit markets than
nominal interest rates

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 FIGURE 2.6 Real and Nominal Interest
Rates (Three-Month Treasury Bill), 1955-
2013

Source: Federal Reserve Bank of St. Louis, FRED Database. http://research.stlouisfed.org/fred2/; with the real interest rate calculated
using the Procedure outlined in Mishkin, Frederic S. 1981. The real interest rate: An empirical investigation. Carnegie-Rochester
Conference Series on Public Policy 15: 151–200.

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 Chapter 3

Aggregate
Production and
Productivity
 Preview

• To understand the production process in the

aggregate economy
• To examine the fundamental factors of
production
• To understand what determines the prices
and income of the factors of production,
and their shares of national income

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 Determinants of Aggregate
Production

• Factors of Production (inputs) include:

– Labor (L)
– Capital (K)
• Both factors are assumed to be exogenous
and fixed over time.

K K
LL

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 FIGURE 1.1 Variables in
Macroeconomic Models

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 Production Function

• Aggregate production function

(production function) is a description of
how much output, Y, is produced for any
given amounts of factor inputs:

Y  F (K, L)

where F is the function that translates K

and L into Y

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 Cobb-Douglas Production Function

• Two observations on a production function:

– An efficient, developed economy generally
produces more with the same quantity of capital
and labor than an inefficient, primitive economy
– The shares of labor and capital income in the
U.S. economy have remained relatively constant
over time at about 70% labor and 30% capital

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 Cobb-Douglas Production Function
(cont’d)

• The Cobb-Douglas production function

incorporates the two ideas:

0.3 0.7
Y  F (K, L)  AK L

where A describes productivity (total

factor productivity)

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 Cobb-Douglas Production Function
(cont’d)

• From the perspective of workers, labor

productivity is the amount of output
produced per unit of labor
• Unlike labor productivity, total factor
productivity takes into account how
productive labor and capital are together

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 Cobb-Douglas Production Function
(cont’d)

Y
A  0.3 0.7
K L
• Example: Y=$10 trillion, K=$10 trillion,
L=100 million workers

10
A 0.3 0.7
 0.20
10 100

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 Application: Why Are Some Countries
Rich and Others Poor?

• Assume that every citizen works, so that

per capita income is the same as average
income (output) per worker, Y/L.
• Income per worker becomes:

0.3 0.7 0.3

Y AK L AK
y    0.3  Ak 0.3
L L L

where k is capital per worker

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 Application: Why Are Some Countries
Rich and Others Poor? (cont’d)

• The shortfall of per capita income in other

countries relative to the United States is
due more to lower productivity than it is to
lower amounts of capital per person

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 TABLE 3.1 PER CAPITA INCOME
RELATIVE TO THE UNITED STATES FOR
DIFFERENT COUNTRIES

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