Basic Concepts and Definitions Prof. Eric Sims University of Notre Dame Fall 2015 1 / 21
Gross Domestic Product (GDP) ◮ Current dollar value of all goods and services produced within a country during a given period of time N ∑ GDP t = p 1, t y 1, t + p 2, t y 2, t + · · · + p N , t y N , t = p j , t y j , t j = 1 ◮ Sometimes called “current dollar GDP” 2 / 21
Expenditure and Income Approaches ◮ As defined, GDP is a measure of production ◮ It is equivalently also a measure of both expenditure and income GDP t = C t + I t + G t + ( X t − IM t ) GDP t = Wages t + Profits t + Interest t + Rent t ◮ C , I , G , X , and IM are expenditure by different types of agents ◮ Wages, profits, interest, and rent are payments to factors of production 3 / 21
Expenditure Categories ◮ C : consumption. Expenditure by households except new residential construction ◮ I : investment. Expenditure by businesses on new capital, plus new residential construction plus net inventory accumulation ◮ G : government spending. Expenditure by government on purchasing things or providing services. Does not include transfers ◮ X : exports. Purchases of stuff made in a country by foreigners ◮ IM : imports. Purchases of a stuff made in a foreign country by people ◮ Caveats about inventories and imports 4 / 21
GDP and Its Components Log Nominal GDP 10 9 8 7 6 5 50 55 60 65 70 75 80 85 90 95 00 05 10 Consumption/GDP Investment/GDP .70 .22 .68 .20 .66 .18 .64 .16 .62 .14 .60 .58 .12 50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10 Gov Spending / GDP Net Exports / GDP .26 .06 .24 .04 .22 .02 .20 .00 .18 -.02 .16 -.04 .14 -.06 50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10 5 / 21
Real vs. Nominal ◮ Money ( M ) a unit of account, acts as the numeraire ◮ Nominal price: denominated in units of money ◮ Price is relative: it is how many units of money it takes to get a unit of a good: e.g. $2 per soda ◮ Real price: denominated in units of a good: e.g. 2 sodas per burger ◮ In single good world, real is quantity, nominal is dollar value of quantity 6 / 21
Real vs. Nominal: Multiple Goods ◮ In multiple good world denominating in units of a good is problematic and arbitrary ◮ NIPA accounts: “constant dollar” GDP = “real GDP” ◮ Pick a base year, b , and use fixed year prices to calculate “constant dollar” GDP: N ∑ Y t = p 1, b y 1, t + p 2, b y 2, t + · · · + p N , t y N , t = p j , b y j , t j = 1 ◮ Still denominated in units of money, but can make comparisons across time without worrying about general price changes driving them 7 / 21
Implicit Price Index ◮ From calculating constant dollar GDP, we can define an implicit price index as the ratio of nominal to real GDP in any year: p 1, t y 1, t + p 2, t y 2, t + . . . p N , t y N , t P t = p 1, b y 1, t + p 2, b y 2, t + · · · + p N , b y N , t ◮ By construction, this is equal to 1 in the base period (when b = t ) ◮ If all prices rising over time, nominal GDP will grow faster than real, so P will rise ◮ Inflation: period-over-period growth rate of price index (or log first difference as approximation) ◮ Frequency conversion: if you observe quarterly data, common to convert to annual frequency. Given quarterly observations, with π t = P t − P t − 1 ≈ ln P t − ln P t − 1 , conversion to annual is P t − 1 t = ( 1 + π t ) 4 ⇒ π A 1 + π A t ≈ 4 π t 8 / 21
Chain-Weighting ◮ Choice of base year arbitrary ◮ Not innocuous if relative prices are changing over time: e.g. price of computers relative to food has fallen ◮ Chain-weighting tries to deal with this ◮ Basic gist: calculate real using different base years, translate into growth rates, and then average 9 / 21
Real GDP Real GDP and Trend Detrended Real GDP 10.0 .10 .05 9.5 .00 9.0 -.05 8.5 -.10 Real GDP 8.0 Trend -.15 7.5 -.20 50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10 10 / 21
Observations ◮ Upward trend really stands out. Blips minor in comparison ◮ Caveat: recent decline relative to trend is large: ≈ 15 % ◮ Tradition to study these separately: growth (trend) and business cycles (gyrations about trend) ◮ Different ways of detrending and isolating the cycles around the trend ◮ For example, allow trend to be non-linear through some kind of smoothing. Doesn’t change qualitative picture, but would get different quantitative implications (e.g. not so far below trend at present) 11 / 21
Price Deflator GDP Deflator Inflation 4.8 .04 4.4 .03 4.0 .02 3.6 .01 3.2 .00 2.8 -.01 2.4 -.02 50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10 12 / 21
Observations ◮ Prices also increase over time on average ◮ Most notable in 1970s ◮ Inflation lower and more stable since early 1980s 13 / 21
Per Capita ◮ Common to express things as “per capita” – divided by population ◮ L : population ◮ GDP t = Y t L t × P t × L t ◮ g GDP ≈ g Y / L + π t + g L t t t ◮ Averages in data (annual): nominal GDP, 6%; real GDP, 3 percent; inflation, 3 percent; population, 1 percent ◮ Given this approximation: per capita real GDP grows by about 2% per year on average (in actuality about 1.8%) 14 / 21
CPI ◮ Consumer price index: popular measure of average cost of living ◮ Trying to measure same thing as GDP deflator, but conceptually different ◮ Pick base year. Fix base year quantities of a defined “basket” of goods that avg. household consumes ◮ Price index: ratio of cost of basket in year t to cost in base year: = p 1, t x 1, b + p 2, t x 2, b + . . . p N , t x N , b P CPI t p 1, b x 1, b + p 2, b x 2, b + . . . p N , b x N , b ◮ Can again measure inflation as period-over-period growth rate of price index 15 / 21
CPI Consumer Price Index CPI Inflation 5.5 .05 .04 5.0 .03 .02 4.5 .01 4.0 .00 -.01 3.5 -.02 3.0 -.03 50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10 16 / 21
Observations ◮ Average annual CPI inflation 3.6 percent, higher than deflator ◮ Also more volatile ◮ Substitution bias: relative price changes cause people to substitute away from relatively more expensive goods. Fixing base quantities ignores this, leads to overstatement of inflation ◮ Can also do chain-weighting with the CPI – attempt to at least partially address the substitution bias. Politically relevant. 17 / 21
Aggregate Labor Market Notation ◮ L : population ◮ E : employment ( E ≤ L ) ◮ h : average hours worked per employee ◮ N = h × E : total hours worked ◮ n = h × E L : hours worked per capita ◮ U : unemployed, actively looking for work but not employed ◮ LF = E + U : labor force U ◮ u = LF : unemployment rate ◮ lf = LF L : labor force participation rate 18 / 21
Labor Market Variables Hours per capita Unemployment rate -7.55 11 10 -7.60 9 8 -7.65 7 6 -7.70 5 4 -7.75 3 -7.80 2 50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10 Labor force participation Employment-Population ratio Average weekly hours 68 66 4.80 64 4.76 66 62 4.72 64 60 4.68 62 58 4.64 60 56 4.60 58 54 4.56 50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10 50 55 60 65 70 75 80 85 90 95 00 05 10 19 / 21
Observations ◮ No strong trend in hours per capita ◮ Downward trend in average hours per worker, upward trend in labor force participation ◮ Hours, average hours, and employment fall in recessions; unemployment rises ◮ Interesting longer run trends in labor force participation: rose from 1960-2000, has been declining since 20 / 21
Problems with Unemployment ◮ Unemployment popular in media, but hard to interpret ◮ Discouraged workers: unemployment can fall if people quit looking for work ◮ Unemployment does not reflect part time work ◮ Hours worked per capita most comprehensive measure of strength of labor market 21 / 21
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