Lecture 2:

Comparing GDP over Time

January 21, 2016

Prof. Wyatt Brooks

MEASURING A NATION’S INCOME 0

 GDP across Time
 Economic History:
 When was the United States most prosperous?
(highest GDP)
 How do changes in GDP over time correlate
with other events?
 Have to be careful when we compare GDP
across time
 Prices change (inflation)
 Need to “deflate” GDP to make them into
comparable units (e.g., 2005 US dollars)
MEASURING THE COST OF LIVING 1
 Prices

 Prices change a lot over time

 More subtle issues:
 Not buying the same things at all times
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 Real versus Nominal GDP
 Inflation is the reduction in the purchasing power
of the currency over time
 Inflation can distort economic variables like GDP,
so we have two versions of GDP:
One is corrected for inflation, the other is not.
 Nominal GDP values output using current prices.
It is not corrected for inflation.
 Real GDP values output using the prices of
a base year. Real GDP is corrected for inflation.

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 The GDP Deflator
 The GDP deflator is a measure of the overall
level of prices.
 Definition:
nominal GDP
GDP deflator = 100 x
real GDP

 One way to measure the economy’s inflation

rate is to compute the percentage increase in
the GDP deflator from one year to the next.

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ACTIVE LEARNING 1
Computing GDP
2007 (base yr) 2008 2009
P Q P Q P Q
Good A $30 900 $31 1,000 $36 1050
Good B $100 192 $102 200 $100 205

Use the above data to solve these problems:

A. Compute nominal GDP in 2007.
B. Compute real GDP in 2008.
C. Compute the GDP deflator in 2009.
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ACTIVE LEARNING 1
Answers
2007 (base yr) 2008 2009
P Q P Q P Q
Good A $30 900 $31 1,000 $36 1050
Good B $100 192 $102 200 $100 205
A. Compute nominal GDP in 2007.
$30 x 900 + $100 x 192 = $46,200

B. Compute real GDP in 2008.

$30 x 1000 + $100 x 200 = $50,000
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ACTIVE LEARNING 1
Answers
2007 (base yr) 2008 2009
P Q P Q P Q
Good A $30 900 $31 1,000 $36 1050
Good B $100 192 $102 200 $100 205
C. Compute the GDP deflator in 2009.
Nom GDP = $36 x 1050 + $100 x 205 = $58,300
Real GDP = $30 x 1050 + $100 x 205 = $52,000
GDP deflator = 100 x (Nom GDP)/(Real GDP)
= 100 x ($58,300)/($52,000) = 112.1
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ACTIVE LEARNING 1
Computing GDP
2012 (base yr) 2013 2014
P Q P Q P Q
Good A $50 20 $60 20 $80 24
Good B $100 6 $100 8 $90 10
Good C $80 5 $75 6 $100 5
Use the above data to solve these problems:
A. Compute real GDP in 2012.
B. Compute real GDP in 2013.
C. Compute the GDP deflator in 2014.
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ACTIVE LEARNING 1
Computing GDP
2012 (base yr) 2013 2014
P Q P Q P Q
Good A $50 20 $60 20 $80 24
Good B $100 6 $100 8 $90 10
Good C $80 5 $75 6 $100 5
A. Compute real GDP in 2012.
$50 x 20 + $100 x 6 + $80 x 5 = $2000
B. Compute real GDP in 2013.
$50 x 20 + $100 x 8 + $80 x 6 = $2280
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ACTIVE LEARNING 1
Computing GDP
2012 (base yr) 2013 2014
P Q P Q P Q
Good A $50 20 $60 20 $80 24
Good B $100 6 $100 8 $90 10
Good C $80 5 $75 6 $86 5
C. Compute GDP deflator in 2014
Nominal: $80 x 24 + $90 x 10 + $86 x 5 = $3250
Real: $50 x 24 + $100 x 10 + $80 x 5 = $2600
GDP Deflator = 100 x Nominal / Real = 125

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 The Consumer Price Index (CPI)
 GDP Deflator includes the effect of investment
goods, imports, exports and so on…
 Not closely tied to the prices that consumers face
 Use the Consumer Price Index
 A measure of how much it costs to maintain
your standard of living

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 How the CPI Is Calculated
1. Fix the “basket.”
The Bureau of Labor Statistics (BLS) surveys
consumers to determine what’s in the typical
consumer’s “shopping basket.”
2. Find the prices.
The BLS collects data on the prices of all the
goods in the basket.
3. Compute the basket’s cost.
Use the prices to compute the total cost of the
basket.

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 How the CPI Is Calculated
4. Choose a base year and compute the index.
The CPI in any year equals
cost of basket in current year
100 x
cost of basket in base year

5. Compute the inflation rate.

The percentage change in the CPI from the
preceding period.

Inflation CPI this year – CPI last year

= x 100%
rate CPI last year
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 What’s in the CPI Basket?
Housing

3.7% 3.5%
Transportation

6.4%
Food & Beverages
6.5%
42.0%
6.5% Medical care

Recreation
14.8%

Education and
16.7% communication

Apparel

Other
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 Example: Compute CPI
2012 (base) 2013 2014
Beef $3 $2 $2
Corn $1 $2 $2
Rice $2 $2 $5

 Basket: 5 units of beef, 15 of corn and 10 of rice

 Compute CPI in each year
 Compute the inflation rate in 2013 and 2014

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 Example: Compute CPI
2012 (base) 2013 2014
Beef $3 $2 $2
Corn $1 $2 $2
Rice $2 $2 $5

 First, compute cost of basket in each year:

 2012: $3 x 5 + $1 x 15 + $2 x 10 = $50
 2013: $2 x 5 + $2 x 15 + $2 x 10 = $60
 2014: $2 x 5 + $2 x 15 + $5 x 10 = $90
 CPI:
 2012: 100 (base), 2013: 100 x 60/50 = 120,
2014: 100 x 90/50 = 180
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 Example: Compute CPI
2012 (base) 2013 2014
Beef $3 $2 $2
Corn $1 $2 $2
Rice $2 $2 $5

 CPI:
 2012: 100
 2013: 120
 2014: 180
 Inflation Rates:
 2013: (120 – 100)/100 = 20%
 2014: (180 – 120)/120 = 50%
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 Correcting Variables for Inflation:
Comparing Dollar Figures from Different Times

Amount Amount Price level today

in today’s = in year T x
dollars dollars Price level in year T

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 Example: US GDP over time

https://research.stlouisfed.org/fred2/graph/?chart_type=lin
e&recession_bars=on&log_scales=&bgcolor=%23e1e9f0
&graph_bgcolor=%23ffffff&fo=verdana&ts=12&tts=12&txt
color=%23444444&show_legend=yes&show_axis_titles=
yes&drp=0&cosd=1947-01-01%2C1947-01-
01&coed=2015-04-01%2C2015-04-
01&height=445&stacking=&range=Max&mode=fred&id=G
DP%2CGDPC1&transformation=lin%2C&nd=%2C&ost=-
99999%2C&oet=99999%2C&lsv=%2C&lev=%2C&scale=
left%2C&line_color=%234572a7%2C&line_style=solid%2
C&lw=2%2C&mark_type=none&mw=2&mma=0%2C&fml
=a%2C&fgst=lin%2C&fgsnd=2007-12-
01%2C&fq=Quarterly%2C&fam=avg%2C&vintage_date=
%2C&revision_date=%2C&width=670

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 Comparing “Average Wealth” over Time
 Want to eliminate two things that affect GDP to
make it a measure of “average wealth”

1) Inflation: use real variables instead of nominal

2) Population Growth: do everything in “per capita” terms

 Even better than per capita is “per working age

person” for a measure of productivity

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Brief Summary of World GDP Growth, pre-1850
3,200

UK
1,600 Italy
Japan
Iraq
Turkey
South Africa
800
Mexico
USA

400
0 500 1000 1500

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 Industrial Revolution
 In the UK, change in industrial practice
 Use machines, canals and replaceable parts to
speed up production
 Industrialized manufacturing instead of artisan
manufacturing (“mass production”)
 Adoption of these practices was very asymmetric
around the world

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 Post-Industrial Growth
25,600

12,800

UK
USA
6,400
France
Italy
Ireland
3,200 Japan
Iraq
Turkey
South Africa
1,600
Mexico

800

400
0 500 1000 1500 2000

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 What Caused US Growth?
 US society changed over this long period of time
 US government pursued many types of policies
 What effect did they have on growth?

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Female Labor Force Participation Rate
Definition: The fraction of the adult, female
population in the workforce.

Why might this matter?

 Higher female labor force participation

means more people are working

 More people working means more gets

produced
Female Labor Force Participation Rate
 Government Spending
as a Fraction of GDP
Why might this matter?

 Governments are typically less efficient

producers of goods and services than private
entities

 Less incentive to minimize costs

Government Spending
as a Fraction of GDP
 Fraction of US Labor Force in
Manufacturing
Why might this matter?

 Fewer tangible goods being produced

domestically

 Huge inter-industry reallocation

 People moving into other sectors
(services, information, etc.)
Fraction of US Labor Force in
Manufacturing
 Exports as a Fraction of GDP
Why might this matter?

 Openness to trade is very important in many

countries

 Running huge trade deficits with the rest of

the world
 Has a direct, negative effect on GDP
Exports as a Fraction of GDP
 Top Marginal Income Tax Rate
Marginal Income Tax: The federal income tax
rate on the income of the highest wage
earners

Why might this matter?

 “Job Creators” argument

 High income individuals are typically
business owners and investors who hire
the majority of the workforce

 Higher tax rates reduce incentives to work

 Top Marginal Income Tax Rate
100%

90%

80%

70%

60%

50%

40%

30% Today: 35%

20%

10%

0%
1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
 Growth Experience of the US
We see huge variation across time in all of these
policies and outcomes (and many others)

Prediction: US growth rates should move greatly

with these things.

Thought experiment: Suppose in 1875 someone

was asked how US real GDP per working age
person would evolve over time, and she guessed it
would always grow by 2%.

By how much would she be wrong?

Growth Experience of the
United States: 1875-2010
Growth Experience of the
United States: 1875-2010
 Growth Experience of the US
In this part of the course (until Midterm 1) we will
focus on long run growth

In the second part we will focus on episodes of

recessions and depressions
Note on the Severity of Recessions
Note on the Severity of Recessions

Of course, the effects of

recessions vary widely
across the population!
 Summary
 US economy has remarkably stable 2% real
per capita growth
 Surprisingly invariant to policy

 For this reason, US is a useful benchmark

to compare to other countries

 Growth being stable is far from ordinary, as

we’ll see in many other examples
 Next Class
 Growth over the long run
 Section 6.1 reading and homework

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