# chapter 2 - faculty

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MACROECONOMICS

S E V E N T H E D I T I O N

PowerPoint
®

Slides by Ron Cronovich

N. Gregory
Mankiw

C H A P T E R

The Science of
Macroeconomics

(edited by L. Lamb, 2011)

2

2 0 1 0 U P D A T E

In this chapter, you will learn:

…the meaning and measurement of the

most important macroeconomic statistics:

2.1 Gross Domestic Product (GDP)

2.2 The Consumer Price Index (CPI)

2.3.
The
unemployment rate

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CHAPTER 2

The Data of Macroeconomics

2.1 Gross Domestic Product:

Expenditure and Income

Two ways to look at GDP:

Total expenditure on domestically
-
produced

final goods and services.

Total income earned by domestically
-
located

factors of production.

Expenditure equals income because

every dollar spent by a buyer

becomes income to the seller.

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The Data of Macroeconomics

The Circular Flow

Households

Firms

Goods

Labor

Expenditure (\$)

Income (\$)

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CHAPTER 2

The Data of Macroeconomics

:

The value of output minus

the value of the intermediate goods

used to produce that output

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CHAPTER 2

The Data of Macroeconomics

Final goods, value added, and GDP

GDP

= value of final goods produced

= sum of value added at all stages

of production.

The value of the final goods already includes the
value of the intermediate goods,

so including intermediate
and

final goods in GDP
would be double
-
counting.

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CHAPTER 2

The Data of Macroeconomics

Table 2.1
GDP and the Components of Expenditure: 2008

Mankiw

and
Scarth

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CHAPTER 2

The Data of Macroeconomics

The expenditure components of GDP

consumption,
C

investment,
I

government spending,
G

net exports,
NX

An important identity:

Y = C + I + G + NX

aggregate
expenditure

value of
total output

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CHAPTER 2

The Data of Macroeconomics

Consumption (C)

durable goods

nondurable goods

services

definition: The value of all
goods and services bought
by households. Includes:

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CHAPTER 2

The Data of Macroeconomics

Investment (I)

Spending on goods bought for future use

(
i.e.
, capital goods)

Includes:

Residential fixed investment

Inventory investment

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CHAPTER 2

The Data of Macroeconomics

Investment vs. Capital

Note: Investment is spending on new capital.

Example
(assumes no depreciation)
:

January 1, 2012:

economy has \$500b worth of capital

during 2012:

investment = \$60b

January 1, 2013:

economy will have \$560b worth of capital

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CHAPTER 2

The Data of Macroeconomics

Government spending (G)

G

includes all government spending on goods
and services.

G

excludes transfer payments

because they do not represent spending on
goods and services.

NOW YOU TRY:

An expenditure
-
output puzzle?

Suppose a firm:

produces \$10 million worth of final goods

only sells \$9 million worth

Does this violate the

expenditure

=
output

identity?

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CHAPTER 2

The Data of Macroeconomics

GNP vs. GDP

Gross
National

Product

(
GNP
):

Total income earned by the nation’s factors of
production, regardless of where located

Gross
Domestic
Product

(
GDP
):

Total income earned by domestically
-
located
factors of production, regardless of nationality

GNP

GDP = factor payments from abroad

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CHAPTER 2

The Data of Macroeconomics

Real vs. nominal GDP

GDP is the
value

of all final goods and services
produced.

nominal GDP

measures these values using
current prices.

real GDP

measure these values using the prices
of a base year.

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CHAPTER 2

The Data of Macroeconomics

GDP Deflator

Inflation rate
: the percentage increase in the
overall level of prices

One measure of the price level:
GDP deflator

Definition:

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CHAPTER 2

The Data of Macroeconomics

Chain
-
Weighted Real GDP

Over time, relative prices change, so the base
year should be updated periodically.

In essence,
chain
-
weighted real GDP

updates the base year every year,

so it is more accurate than constant
-
price GDP.

constant
-
price real GDP, because:

the two measures are highly correlated.

constant
-
price real GDP is easier to compute.

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The Data of Macroeconomics

2.2 Consumer Price Index (CPI)

A measure of the overall level of prices

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CHAPTER 2

The Data of Macroeconomics

How CPI is constructed

1
.

Survey consumers to determine composition of
the typical consumer’s “basket” of goods

2
.

Every month, collect data on prices of all items

3
.

CPI in any month equals

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CHAPTER 2

The Data of Macroeconomics

Why the CPI may overstate inflation

Substitution bias

Introduction of new goods

Unmeasured changes in quality

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CHAPTER 2

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Figure 2.3
The Inflation Rate as Measured by the GDP Deflator and the CPI

Mankiw and Scarth: Macroeconomics, Canadian Fourth Edition

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2.3 Measuring Joblessness:

Categories of the population

employed

unemployed

labor force

not in the labor force

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Figure 2.4
The Three Groups of the Population

Mankiw

and
Scarth

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The Data of Macroeconomics

Two important labor force concepts

unemployment rate

labor force participation rate

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CHAPTER 2

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Figure 2.5
Okun’s

Law

Mankiw

and
Scarth

2.4 Chapter Summary

Gross Domestic Product (GDP) measures both
total income and total expenditure on the
economy’s output of goods & services.

Nominal GDP values output at current prices;

real GDP values output at constant prices.
Changes in output affect both measures,

but changes in prices only affect nominal GDP.

GDP is the sum of consumption, investment,
government purchases, and net exports.

Chapter Summary

The overall level of prices can be measured

by either:

the Consumer Price Index (CPI),

the price of a fixed basket of goods
purchased by the typical consumer, or

the GDP deflator,

the ratio of nominal to real GDP

The unemployment rate is the fraction of the
labor force that is not employed.

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The Data of Macroeconomics

Homework

End of chapter 2 in textbook:

Questions for review: 1,2,3,4

Problems & Applications: 2, 3, 4, 6, 7, 8 & 9