Chapter 2

Aggregate Statistics
 Three aggregate statistics

When macroeconomists study an economy they first look at 3 variables:

• Output

• Unemployment rate

• Inflation rate
 Aggregate output

• National income and product accounts

Accounting system used to measure aggregate economic activity
Developed at the end of World War II

• Measure of aggregate output in the national income accounts

Gross Domestic Product (GDP)
 Example A

Steel company (Firm 1)

Revenues from sales €100

Car company (Firm 2)
Expenses €80
Wages €80 Revenues from sales €200

Profits €20 Expenses €170

Wages €70
Steel purchases €100

Profits €30
Consumers

GDP = ?
 GDP: Definition 1 (Demand side)
There are 3 ways of defining GDP:

1. GDP is the value of final goods and services produced in the economy
during a given period

• A final good is a good that is intended for final consumption

• An intermediate good is a good used in the production of another good

→ In example A
Cars are final goods (€200)
Steel is an intermediate good (€100)

GDP = €200
 Example B
Firm 1 merges with Firm 2

Steel and car company (Firm 1+2)

Revenues from sales of cars €200

Expenses €150
Wages €80+€70=€150

Profits €50

Consumers

GDP = ?
→ In example B
No sale or record of intermediate goods, steel
Only production of final goods, cars (€200)

GDP = €200
 GDP: Definition 2 (Production side)

2. GDP is the sum of value added in the economy during a given period

Value added by a firm is the value of its production minus the value of the
intermediate goods used in production

→ In example A
Value added by firm 1 is €100
Value added by firm 2 is €200-€100 =€100

GDP = €100 + €100 = €200

→ In example B, value added by the single firm is €200

GDP = €200
 GDP: Definition 3 (Income side)

3. GDP is the sum of incomes in the economy during a given period

Value added is used to remunerate

• Workers → labor income

• Firms → capital income or profit income
• Government → indirect taxes
(such as VAT or a sale tax), it is a tax collected by an intermediary (such as a retail store)
from the subject who bears the economic burden of the tax (such as the consumer)

→ In examples A and B
Labor income: €150
Capital income: €50
Indirect taxes: €0
GDP = €150 + €50 = €200
 Nominal GDP

" Nominal GDP is the sum of the quantities of final goods produced
multiplied by their current prices

" Nominal GDP increases over time because of 2 reasons

" First, production of most goods increases over time

" Second, prices of most goods also increase over time
 Real GDP

" Real GDP is constructed as the sum of the quantities of final goods
multiplied by constant prices (rather than current)

" Real GDP increases over time because production of most goods
increases over time
Nominal and Real GDP
 Measuring real GDP
" Simple in an economy with one good, say cars

Year Quantity of cars Price of cars Nominal GDP Real GDP

(in 2005 prices)
2004 10 €20,000 €200,000 €240,000

2005 12 €24,000 €288,000 €288,000

2006 13 €26,000 €338,000 €312,000

" To construct real GDP, multiply the number of cars in each year by a common price

" Suppose we use the price of cars in 2005 as the common price

" This approach gives us real GDP in 2005 prices

" 2005 is called the base year

 Issues

" Is real GDP more difficult to measure in an economy with many final goods?

" With more than one good, relative prices of the goods (in the base year) are used
as natural weights

" Will the level and the rate of change of real GDP be different if we use the price in a
different year, say 2006 rather than 2005? We will see that:

" The level always changes with the base year

" The growth rate does not change with one good, but it does with many goods
 GDP: level versus growth rate

• Real GDP level in period t, Yt

• Real GDP growth:

(Yt - Yt-1 ) / Yt-1

• Periods of positive GDP growth are called expansions

• Periods of negative GDP growth (at least 2 consecutive quarters) are called recessions

• The level of real GDP has no economic interpretation (index number);

the rate of change has a clear interpretation (output growth)
 Back to our example
" Simple economy with one good, say cars
Year Quantity of cars Price of cars Nominal GDP Real GDP Real GDP
(in 2005 prices) (in 2006 prices)
2004 10 €20,000 €200,000 €240,000 €260,000

2005 12 €24,000 €288,000 €288,000 €312,000

2006 13 €26,000 €338,000 €312,000 €338,000

" Real GDP growth using real GDP at 2005 prices

" Growth from 2004 to 2005 = (288,000-240,000)/240,000 = 0,2 = 20%
" Growth from 2005 to 2006 = (312,000-288,000)/288,000 = 0,083 = 8,3%

" Real GDP growth using real GDP at 2006 prices

" Growth from 2004 to 2005 = (312,000-260,000)/260,000 = 0,2 = 20%
" Growth from 2005 to 2006 = (338,000-312,000)/312,000 = 0,083 = 8,3%

" With one good, the growth rate of real GDP is unaffected by the base year
GDP growth rate
 Inflation rate

• General level of prices

Average price of goods and services in the economy, Pt

• Inflation rate
Rate at which the general price level grows, πt

πt = (Pt – Pt-1 ) /Pt-1

 Inflation and deflation

• Inflation
Raise in the price level; corresponds to a positive inflation rate

• Deflation
Decline in the price level; corresponds to a negative inflation rate
 Price level

• In an economy with one final good it is straightforward to measure the price level;
with many final goods it is more difficult

• Economists use 2 definitions of the aggregate price level, 2 price indexes

• GDP deflator

• Consumer price index

• The level of prices has no economic interpretation (index number); the rate of
change has a clear interpretation (inflation)
 GDP deflator
• GDP deflator, Pt
GDP deflator in t is defined as the ratio of nominal GDP to real GDP in t

$Yt = Pt Yt
Nominal GDP = GDP deflator x Real GDP

Pt = $Yt / Yt
GDP deflator = Nominal GDP / Real GDP

• Index number
GDP deflator is an index number, set equal to 1 in the base year
 Example

Year Cars Books

QC PC QB PB

2000 12 24,000 10 5,000

2010 13 30,000 20 2,000

Nominal GDP in 2000: 12 x 24,000 + 10 x 5,000 = 338,000

Nominal GDP in 2010: 13 x 30,000 + 20 x 2,000 = 430,000
 Example (continued)

Year Cars Books

QC PC QB PB

2000 12 24,000 10 5,000

2010 13 30,000 20 2,000

Real GDP-2000 (at 2000 prices): 12 x 24,000 + 10 x 5,000 = 338,000

Real GDP-2010 (at 2000 prices): 13 x 24,000 + 20 x 5,000 = 412,000
 Example (continued)

€Y2000 338,000
Deflator-2000 (at 2000 prices): P2000 = = =1
Y2000 338,000

€Y2010 430,000
Deflator-2010 (at 2000 prices): P2010 = = = 1.044
Y2010 412,000

P2010 - P2000 1.044 - 1

Inflation rate:
p 2000 - 2010 = = = 0.044
P2000 1
 Example (continued)
• Does the inflation rate depend on the base year chosen? Yes

• Does the growth rate of real GDP depend on the base year chosen?
Yes
Year 2000 2010 Growth

Nominal GDP 338,000 430,000 0.272

Real GDP (at 2000 prices) 338,000 412,000 0.219

Real GDP (at 2010 prices) 380,000 430,000 0.132

Deflator (at 2000 prices) 1.000 1.044 0.044

Deflator (at 2010 prices) 0.889 1.000 0.125

• Note that the rate of growth of nominal GDP is approximately equal to the
rate of growth of real GDP plus the rate of inflation
 The Consumer Price Index (CPI)

" The GDP deflator measures the average price of output, i.e., of the final
goods produced in the economy

" The consumer price index, or CPI, measures the average price of
consumption, i.e., of the goods consumed by the households

" The CPI gives the cost in dollars of a specific list of goods and services
over time, which attempts to represent the consumption basket of a
typical urban consumer

" The CPI measures the cost of living

The set of goods produced in the economy is not the same as the set of
goods purchased by consumers, for two reasons:

• Some of the goods are sold to firms, to the government or to

foreigners

• Some of the goods are not produced domestically but are imported
from abroad
 Inflation rate

Inflation rate in the EU, Using the HICP and the GDP Deflator, 1997-
2014
(percent per year)
6.0

5.0

4.0

3.0

2.0

1.0

0.0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

GDP deflator HICP

The inflation rates, computed using either the HICP or the GDP deflator, are largely
similar.
 Why do economists care about inflation?

Pure inflation: proportional increase in all prices and wages

• All relative prices unaffected

• Real wages for example unaffected

Economists care about inflation for two reasons:

• During periods of inflation, not all prices and wages rise proportionately,
inflation affects relative prices and income distribution (no pure inflation)

• Inflation leads to other distortions due to uncertainty, prices that are fixed
by law or regulation, and interaction with taxation
 Unemployed workers
Thousands of unemployed people wait outside the State Labor Bureau in New York City to register for federal relief jobs in 1933

People who don’t have a job but are looking for one
Discouraged workers

People without jobs who give up looking for work

 Measuring unemployment

• Measuring whether a person is employed is straightforward; measuring

whether a person is unemployed is less obvious

• Until recently, only available source to measure unemployment was the

number of people registered at unemployment offices

• This was a poor measure of unemployment: it depends on the generosity

of unemployment benefit systems and on the exhaustion of benefits

• Most countries now rely on Labor Force Surveys (LFS): interviews of

representative samples of individuals
" Working age population
Number of people who can work, P

" Employment
Number of people who have a job, N

" Unemployment
Number of people who don’t have a job but are looking for one, U

" Labor force

Sum of employment and unemployment, L
 L = N + U
Labor force = Employment + Unemployment

P = L + Out of labor force

Working age population = Labor force + Out of the labor force
 Unemployment rate

Ratio of unemployed people to the number of people in the labor force, u

u=U/L

Example: In 2008 in the US 144.4 million people were employed, 7.0 million
people were unemployed, so the unemployment rate was 7.0/(144.4 +
7.0) × 100 =7.1%

Question: what would happen to the unemployment rate if all workers

without a job gave up looking for one?
 Unemployment rate

Unemployment rates in the EU15, UK and the USA since 1960s

13

11

1
1960s
1970s
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
EU15 UK US

Since the 1960s, the unemployment rate has fluctuated between less than 2% and more than 11% both in
Europe and in the US, going down during expansions and going up during recessions. The effect of the crisis
is highly evident, with the unemployment rate close to 10% in the EU15.
 Participation rate

Ratio of people in the labor force to the working age population

participation rate = L / P
= (N + U) / (N + U + Out of L)

Question: what happens to the unemployment rate if the participation rate

decreases because some unemployed leave the labor force?
Participation and Unemployment Rates
Participation and unemployment rates in the USA since 2000
 Participation rate
Labor force participation rates by sex, selected countries, 2010

Source: US Bureau of Labor Statistics and International Labor Office

Why do economists care about unemployment?

Economists care about unemployment for two reasons:

" Because of its direct effects on the welfare of the unemployed,

especially the long-term unemployed

" Because it provides a signal that the economy may not be using
some of its resources efficiently
 Short run, medium run and long run

Level of aggregate output in an economy is determined by:

• Demand in the short run (a few years)

• Level of technology, the capital stock and the labor force in the
medium run (a decade or so)

• Factors such as education, research, saving and the quality of

government in the long run (half a century or more)