MACROECONOMICS

L Phng Tho Qunh

FACULTY OF INTERNATIONAL ECONOMICS
Mobile: 0987027398
Email: phuongthaoquynhle@yahoo.com.vn

LECTURE 2:
MEASURING MACROECONOMIC VARIABLES

MEASURING A NATIONS INCOME

Macroeconomics answers questions such as:
Why is average income high in some countries and
low in others?
Why do prices rise rapidly in some periods while
they are more stable in other periods?
Why do production and employment expand in
some years and contract in others?

THE ECONOMYS INCOME AND

EXPENDITURE

When judging whether the economy is doing well or

poorly, it is natural to look at the total income that
everyone in the economy is earning.

THE ECONOMYS INCOME AND

EXPENDITURE
For an economy as a whole, income must equal
expenditure because:
Every transaction has a buyer and a seller.
Every dollar of spending by some buyer is a dollar
of income for some seller.

THE MEASUREMENT OF GDP

Gross domestic product (GDP) is a measure of the

total income and expenditures of an economy.

It is the total market value of all final goods and

services produced within a country in a given period
of time.

THE MEASUREMENT OF GDP

GDP is the market value ...

Output is valued at market prices.

... of all final ... It records only the value of final

goods, not intermediate goods (the value is counted
only once).
... goods and services ... It includes both tangible
goods (food, clothing, cars) and intangible services
(haircuts, house cleaning, doctors visits).

THE MEASUREMENT OF GDP

... produced ... It includes goods and services

currently produced, not transactions involving
goods produced in the past.

... within a country ... It measures the value of

production within the geographic confines of a
country.
... in a given period of time. It measures the value
of production that takes place within a specific
interval of time, usually a year or a quarter (three
months).

THE COMPONENTS OF GDP

GDP includes all items produced in the economy

and sold legally in markets.

What is not counted in GDP?

GDP excludes most items that are produced and
consumed at home and that never enter the
marketplace.
It excludes items produced and sold illicitly, such as
illegal drugs.

THE CIRCULAR-FLOW DIAGRAM

THE CIRCULAR-FLOW DIAGRAM

Sectors

of
a
simple
economy:
1) Households contain all the people
2) Firms all the business enterprises

THE CIRCULAR-FLOW DIAGRAM

Sectors are connected by 2 markets: factor and product market:
1) Households sell productive services to firms through factor
markets
- The factors of production are land, labor, capital.
- When households sell productive services to firms, they
receive income: wages, rent, profits, interest
2) Firms sell goods & services in product markets
- The income of firms in this market is also the expenditure of
households

THE CIRCULAR-FLOW DIAGRAM

-

Underlying principle of the circular flow: the dollar

inflow into each market or sector must equal the
dollar outflow from each market or sector

So, total production = total spending = total income

COMPONENTS OF GDP

GDP (Y) is the sum of the following:

consumption (C)
investment (I)
government purchases (G)
net exports (NX)
Y = C + I + G + NX

COMPONENTS OF GDP

Consumption (C):
The spending by households on goods and
services, with the exception of purchases of new
housing.

Investment (I):
The spending on capital equipment, inventories
and structures, including household purchases of
new housing.

COMPONENTS OF GDP

Government purchases (G):

The spending on goods and services by local,
State and federal governments
Does not include transfer payments because they
are not made in exchange for currently produced
goods or services

Net exports (NX): Exports minus imports.

NX = X - M

REAL VERSUS NOMINAL GDP

Nominal GDP:
Nominal GDP values the production of goods and
services at current prices.
n

GDP = q p
t

i=1

q: quantity
p: price
t: current year
i: good number i in n products

REAL VERSUS NOMINAL GDP

In reality, GDPn often increases from year to year.

Only looking at GDPn we can not know whether the
increase comes from price or quantity.

REAL VERSUS NOMINAL GDP

Real GDP (GDPr) values the production of goods

and services at constant prices.
t = 0 is base year

GDP

t
r

= q
i=1

t
i

0
i

REAL VERSUS NOMINAL GDP

If GDPr increases, it exactly comes from the

increase in quantity

=> GDPr is used to measure economic growth

GDP DEFLATOR

GDP Deflator-D GDP): The GDP deflator is a

measure of the price level calculated as the ratio of
nominal GDP to real GDP times 100.

It tells us the rise in nominal GDP that is attributable

to a rise in prices rather than a rise in the quantities
produced..
t
t

DGDP

= GDP nt 100

GDP

GDPN, GDPR AND GDP DEFLATOR

P book

Q book

P pen

Q pen

2011

100

75

2012

150

100

2013

200

150

GDPN, GDPR AND GDP DEFLATOR

2011 is base year

Year

Nominal GDP

2011

100 x 5 + 3 x 75 = 725

2012

6 x 150 + 4 x 100 = 1300

2013

7 x 200 + 5 x 150 = 2150

GDPN, GDPR AND GDP DEFLATOR

Year

Real GDP

2011

5 x 100 + 3 x 75 = 725

2012

5 x 150 + 3 x100 = 1050

2013

5 x 200 + 3 x 150 = 1450

GDPN, GDPR AND GDP DEFLATOR

Year

D GDP = (GDPn/GDPr) x 100

2011

D GDP = 725/725 x 100 = 100

2012

D GDP = 1300/1050 x 100 = 124

2013

D GDP = 2150/1450 x 100 = 148

GDPN, GDPR AND GDP DEFLATOR

rate in 2012 = (124 100)/100 = 24%

Inflation rate in 2013 = (148 124)/124 = 19.35%
Inflation

GDP AND ECONOMIC WELLBEING

GDP is the best single measure of the economic
wellbeing of a society.
GDP per person tells us the income and
expenditure of the average person in the economy.
Higher GDP per person indicates a higher standard
of living.
However, GDP is not a perfect measure of the
happiness or quality of life.

GDP AND ECONOMIC WELLBEING

Some things that contribute to wellbeing are not

included in GDP:
the value of leisure
the value of a clean environment
the value of almost all activity that takes place
outside of markets, such as the value of the time
parents spend with their children and the value of
volunteer work.

GDP PER CAPITA OF SOME NATIONS IN 2012

GDP AND QUALITY OF LIFE

CONSUMER PRICE INDEX - CPI

CPI
The consumer price index (CPI) is a measure of the
overall cost of the goods and services bought by a
typical consumer.
-

When the CPI rises, the typical family has to spend

more dollars to maintain the same standard of
living.
The Vietnamese Bureau of Statistics reports the
CPI each month.

HOW THE CPI IS CALCULATED?

B1: Fix the base year and the basket
0
of goods and services q i

- Year 2010
- Basket: 10kg rice v 5kg fish

B2: Determine the prices of each of

the goods and services in the basket
for each point in time.
p

Nm
2010
2011
2012

t
i

Gi go
3
4
5

Gi c
15
17
22

B3: Calculate the baskets cost: Use

2010: 3 x 10kg go + 15 x 5kg c = 105
the data on prices to calculate the
2011: 4 x 10kg go + 17 x 5kg c = 125
cost of the basket of goods and
2012: 5 x 10kg go + 22 x 5kg c = 160
t
0
services at different times. CP t = pi qi

B4: Compute the index

CPI

= ( p

t
i

q p q ) 100
t

B5: Compute inflation rate

CPI - CPI 100%
CPI
t -1

t -1

2010: = (105/105) X 100 = 100

2011: = (125/105) X 100 = 119
2012: = (160/105) X 100 = 152.4
T l lm pht nm 2011:
(119 - 100)/100 x 100% = 19%
T l lm pht nm 2012:
(152.4 119)/119 x 100% = 28%

PROBLEMS IN MEASURING THE COST

OF LIVING

The CPI is an accurate measure of the selected

goods that make up the typical bundle, but it is not
a perfect measure of the cost of living
substitution bias
introduction of new goods
unmeasured quality changes

PROBLEMS IN MEASURING THE

COST OF LIVING
Substitution bias:
- The basket does not change to reflect consumer
reaction to changes in relative prices.
- Consumers substitute toward goods that have
become relatively less expensive.
- The index overstates the increase in cost of living
by not considering consumer substitution.

PROBLEMS IN MEASURING THE COST

OF LIVING

Introduction of new goods:

- The basket does not reflect the change in
purchasing power brought on by the introduction of
new products.
- New products result in greater variety, which in
turn makes each dollar more valuable.
- Consumers need fewer dollars to maintain any
given standard of living.

PROBLEMS IN MEASURING THE

COST OF LIVING

Unmeasured quality changes

If the quality of a good rises from one year to the

next, the value of a dollar rises, even if the price of
the good stays the same.

CORRECTING ECONOMIC VARIABLES

FOR THE EFFECTS OF INFLATION

Price indexes are used to correct for the effects of

inflation when comparing dollar figures from
different times.

DOLLAR FIGURES FROM DIFFERENT TIMES

INDEXATION

When some dollar amount is automatically

corrected for inflation by law or contract, the
amount is said to be indexed for inflation.

REAL AND NOMINAL INTEREST RATES

Interest represents a payment in the future for a
transfer of money in the past.
The nominal interest rate is the interest rate usually
reported and not corrected for inflation. It is the
interest rate that a bank pays.
The real interest rate is the nominal interest rate that
is corrected for the effects of inflation.

REAL AND NOMINAL INTEREST RATES

Real interest rate = Nominal interest rate Inflation rate

r=i-

QUESTIONS
1.

GDP is equal to

a.

The total value of goods and services produced in an economy

during a given period

b.

C + I +G +IM

c.

The total value of intermediate goods plus final goods

d.

The total income received by producers of final goods and services

2. Which of the following is included in GDP?

a.

Changes to inventories

b.

Intermediate goods

c.

Used goods

d.

Financial assets

e.

Foreign produced goods

QUESTIONS
3. Which is the following is not included in GDP:
a.
Capital goods such as machinery
b.
Imports
c.
The value of domestically produced services
d.
Government purchases of goods and services
e.
The construction of structures