Introduction GDP Other Variables

Principios de Macroeconomı́a :

Lecture 1

Brian Tavares
Universidad Diego Portales

August 10, 2017

Branches of Economics
 Microeconomics is concerned with the study of the choice
problem faced by the economic agents: households and
firms
 e.g., how the equilibrium price for a particular
commodity is determined

 Macroeconomics is concerned with the study of the

economy as a whole
 e.g., how the general level of prices is determined (and
not the price of any particular commodity)

© Gustavo Indart Slide 2

The Object of Macroeconomics
 How the general level of prices is determined?
 What determines the percentage of the labour force that is
unemployed?
 What determines a country’s level of aggregate output or
GDP?
 What determines the level of interest rates?
 What determines the foreign exchange rate?
 What determines a country’s balance of payments with the
rest of the world?

© Gustavo Indart Slide 3

 Aggregate Output (GDP)
Gross Domestic Product (GDP) is the value of all final goods
and services produced in the economy during a given period
of time

 Nominal GDP measures the value of output at the prices

prevailing in the period the output is produced

 Real GDP measures the output at the prices of some base

year

© Gustavo Indart Slide 10

Canada: Growth in Aggregate Output

Source: P. Krugman, R. Wells and A. Myatt, Macroeconomics.

© Gustavo Indart Slide 11

 Canada: Real GDP Growth
January 2004 to May 2016

Source: Trading Economics / Statistics Canada.

© Gustavo Indart Slide 12

Canada: Growth in Aggregate Output

Source: P. Krugman, R. Wells and A. Myatt, Macroeconomics.

© Gustavo Indart Slide 13
Canada: Real GDP per Capita

Source: P. Krugman, R. Wells and A. Myatt, Macroeconomics.

© Gustavo Indart Slide 14
Gross Domestic Product
 Gross Domestic Product (GDP) is the value of all final goods 
and services produced in Canada during a given period of 
time
 That is, GDP is a flow of new products during a period of 
time, usually one year

 We can use three different approaches to measure GDP:
 Production approach
 Expenditure approach
 Income approach

© Gustavo Indart Slide 2
Measuring GDP
 Production Approach – We can measure GDP by measuring 
the value added in the production of goods and services in 
the different industries (e.g., agriculture, mining, 
manufacturing, commerce, etc.)

 Expenditure Approach – We can measure GDP by measuring 
the total expenditure on final goods and services by different 
groups (households, businesses, government, and foreigners)

 Income Approach – We can measure GDP by measuring the 
total income earned by those producing goods and services 
(wages, rents, profits, etc.)

© Gustavo Indart Slide 3
Flow of Expenditure and Income

Labour, land  FACTORS Labour, land 

& capital MARKETS & capital

Wages, rent & 
interest

HOUSEHOLDS
FIRMS
Expenditures 
on goods & 
services

Goods & 
services GOODS Goods & 
MARKETS services

© Gustavo Indart Slide 4
Measuring GDP
 Current Output – GDP includes only the value of output 
currently produced. For instance, GDP includes the value of 
currently produced cars and houses but not the sales of used 
cars and old houses

 Market Prices – GDP values goods at market prices, and the 
market price of a good includes indirect taxes (and subsidies) 
such as sales taxes and excise taxes 

 Not All Goods and Services Are Considered – In general, only 
the value of goods and services exchanged in the market –
except illegal transaction (e.g., drugs) – are included in GDP, 
but there are some other services arbitrarily added (such as 
the imputed rent to owners’ occupied houses)
© Gustavo Indart Slide 5
The Production Approach
 GDP is the value of final goods and services produced in 
Canada within a year
 The emphasis on the word final (goods and services) is 
important in order to avoid double counting

 If we were to consider also the value of intermediate goods, 

then their values would be counted twice: 
 First, as an output of the industry producing this 
intermediate good
 Second, as part of the value of the final good of the 
industry that uses it as an intermediate good

© Gustavo Indart Slide 6
The Production Approach (cont’d)
 To avoid this double counting we must consider only the 
value added in each industry or at each stage in the 
process of manufacturing a good 

 The value added by a firm is the difference between the 
revenue the firm earns by selling its product and the 
amount it pays for the product of other firms it uses as 
intermediate goods

© Gustavo Indart Slide 7
Example
 Suppose that the production and sale of bread in a given 
period of time is $1000, and that the flour used in the 
production of this bread costs $400

 Also suppose that $200 worth of wheat is needed to produce 
this $400 worth of flour 

 What is the contribution of these activities to GDP?

 The contribution to GDP is only $1,000 since bread is the only 
final good (flour and  wheat are both intermediate goods)

© Gustavo Indart Slide 8
Example (cont’d)
Value of 
Product Value Added
Output

Bread $1000 $600

Flour $400 $200

Wheat $200 $200

Total $1600 $1000

© Gustavo Indart Slide 9
The Expenditure Approach
 Total spending on goods and services produced in Canada 
during any period can be broken down as follows:
GDP = Consumption
+ Investment
+ Government expenditure
+ Net exports (or exports minus imports)
or, in symbols, Y = C + I + G + NX

 Here we are measuring GDP taking into account who buys the 
output

© Gustavo Indart Slide 10
 Consumption Expenditure
 Consumption spending is the largest component of GDP

 It includes:
 Services (haircuts, medical care, education)
 Durable goods (cars, stereos, washing machines) 
 Non‐durable goods (food, clothing, gasoline)

 Note that the purchase of durable goods could be argued to 
be an investment since they are not completely consumed 
during the period when they are purchased

© Gustavo Indart Slide 11
Investment Expenditure
 For GDP purposes, investment spending is the type of 
expenditure that results in an addition to the physical stock of 
capital
 Therefore, investment does not include buying a bond or 
stock in a company
 Investment includes expenditure on:
 machinery and equipment Business fixed 
 non‐residential construction capital investment
 residential construction
 changes in inventories
 Investment expenditure includes private investment but not 
government investment
© Gustavo Indart Slide 12
Investment Expenditure (cont’d)
 Investment is a flow of new capital during the year that is 
added to the stock of capital
 The capital stock is the total amount of capital in the 
economy (all buildings, equipment, and houses)
 The capital stock increases from one year to the next as a 
result of investment 
 However, not all investment expenditure is devoted to 
increasing the capital stock
 Because the capital stock is constantly wearing out (i.e., 
depreciating), part of the investment is devoted to 
replacing worn‐out capital
 Net investment is gross investment minus depreciation 
 What is reported in GDP is gross investment
© Gustavo Indart Slide 13
Government Expenditure
 Government spending (federal, provincial, territorial, and 
municipal) on goods and services is the second largest 
component of GDP

 It includes the salaries of all government employees and 
expenditures on such items as road paving, military airplanes, 
and advertising

 It also includes government investment expenditure

 It does not include transfer payments such as welfare 
payments and interest payments on the national debt

© Gustavo Indart Slide 14
Net Exports
 Exports are added in as they represent spending by foreigners 
on Canadian goods and services
 Imports are subtracted since they represent the part of 
domestic spending that is not on domestically produced 
goods and services
 Consumption, investment, and government expenditure 
include spending on both domestically produced and foreign 
produced goods
 To obtain total spending on domestically produced goods 
(GDP), imports must be subtracted

© Gustavo Indart Slide 15
Canada’s GDP, 2012
At Market Prices  As % of GDP
($ millions)
Consumption 1,012,386 55.6
Investment 371,552 20.4
Government 471,707 25.9
Exports 546,617 30.0
Imports 582,829 32.0
Statistical discrepancy 534 ...
GDP 1,819,967 100.0
Source: Statistics Canada.

© Gustavo Indart Slide 16
The Income Approach
 Those Canadians who contribute towards the production of 
GDP receive income for their services
 The value added in production – i.e., the difference between 
the revenue from selling the product and the cost of the 
intermediate goods (and services) used in its production –
must be somebody’s income (wages, rents, profits, etc.)
 But not all of the value added represents someone's income
 Part of GDP goes as depreciation (which is a cost of 
production) and thus can’t be counted as part of anyone’s 
income
 Also GDP is valued at market prices which include indirect 
taxes minus subsidies and the income accruing to 
producers does not include these net indirect taxes
© Gustavo Indart Slide 17
Net Domestic Income
 The part of the value added that goes to payment to the 
owners of the different factors of production is called Net 
Domestic Income (NDI) 
 NDI = GDP – net indirect taxes – depreciation

 Net domestic income is also equal to the sum of all the 
different sources of income: wages and salaries + corporate 
profits + interest + rents + net income of unincorporated 
business

 Net Domestic Income is also called Net Domestic Product at 
factor cost
 Net Domestic Product at market prices is GDP minus 
depreciation
© Gustavo Indart Slide 18
Personal Income
 From Net Domestic Income we can obtain Personal Income

 Personal Income is the income received by individuals, that is, 
by households 

 Therefore, to get to Personal Income we have to subtract 
corporate profits from Net Domestic Income and add 
dividends, government transfer payments, and interest on 
government debt

 Transfers are payments that do not arise out of current 

productive activity, that is, they are not payments for the 
service of a factor of production

© Gustavo Indart Slide 19
Personal Disposable Income
 Personal Disposable Income is the amount of income 
available for consumption

 To obtain Personal Disposable Income we must subtract 
Personal Income Taxes from Personal Income

 Not all Personal Disposable Income is spent on personal 
consumption – i.e., a fraction is saved 

 Therefore, Personal Disposable Income = 
Personal Consumption Expenditure 
+ Personal Saving

© Gustavo Indart Slide 20
Gross Domestic Product vs. Gross 
National Product
 Gross Domestic Product (GDP) measures production within
Canada taking into account the contributions of both 
Canadian and non‐residents’ factors of production

 Gross National Product (GNP) measures production within
and outside Canada taking into account the contributions of 
only Canadian factors of production
 Therefore, using the income approach we consider only 
payments to Canadian factors of production both at home 
and abroad
 GNP represents the national income of the country

© Gustavo Indart Slide 21
Real and Nominal GDP
 Nominal GDP measures the value of output in a given period 
in the prices of that period, that is, in current dollars
 Nominal GDP changes from year to year because the 
physical output changes and also because market prices 
change

 Real GDP measures the value of output in a given period in 
the prices of a base period, that is, in constant dollars
 Therefore, real GDP changes from year to year only 
because the physical output changes

© Gustavo Indart Slide 22
Introduction GDP Other Variables

PIB real
Introduction GDP Other Variables

PIB real
Introduction GDP Other Variables

Nominal and Real

• GDP US:
• 1960: 13,8 trillion
• 2007: 520 trillion
• Was GDP really 26 times bigger in 2007?
Introduction GDP Other Variables

Nominal The sum of the quantities (final goods) multiplied by its current.
• Increases if production increases
• Increases if prices increase
Introduction GDP Other Variables

Example of calculating nominal GDP:

Table: Calculating nominal GDP

Year Quantity apples Price of apples Quantity of Oranges Price of Oranges

2000 50 1,00 60 0,75
2010 100 0,50 20 1,00

• 2000 : 50 ∗ 1, 00 + 60 ∗ 0, 75 = 95
• 2010 : 100 ∗ 0, 50 + 20 ∗ 1, 00 = 70
Introduction GDP Other Variables

• Calculating a rate of change for a variable y:

• (yyear t -yyear t−1 )/yyear t )x100
• Rate of change of nominal GDP in example: ((70-95)/95)x100 =
-35,71%
• Nominal GDP has decreased
• But the quantity of apples has increased
• The decrease in the price of apples is responsible
Introduction GDP Other Variables

Clearer example:

Table: Calculating nominal GDP

Year Quantity apples Price of apples Quantity oranges Price of oranges
2000 50 1,00 60 0,75
2010 100 0,50 60 0,50

• 2000 : 50 ∗ 1, 00 + 60 ∗ 0, 75 = 95
• 2010 : 100 ∗ 0, 50 + 60 ∗ 0, 50 = 80
• Change in rate (∆%) nominal PIB : ((80-95)/95)x100 = -0.1579%
Introduction GDP Other Variables

• Why did nominal GDP fall?

• The production increased but prices decreased
• What is important from the point of view of society?
• Only the production of goods and services!
Introduction GDP Other Variables

• Real GDP attempts to solve this problem

• Strategy of real GDP:
• Fix the prices (using a base year) and use a specific year’s prices
• Base year:
• The year whose prices are selected
• Notation : PIBbase
t
year
Introduction GDP Other Variables

Example:

Table: Calculating real GDP

Year Quantity Apples Price of Apples Quantity of Oranges Price of Oranges
2000 50 1,00 60 0,75
2010 100 0,50 60 0,50
Introduction GDP Other Variables

Using base year 2000

PIB2000
2000 = $1, 00x50 + $0, 75x60 = 95
PIB2000
2010 = $1, 00x100 + $0, 75x60 = 145

Using base year 2010

PIB2010
2000 = $0, 50x50 + $0, 50x60 = 55
PIB2010
2010 = $0, 50x100 + $0, 50x60 = 80
Introduction GDP Other Variables

Rates of change in Real GDP:

2000
• ∆%PIB2000,2010 = 0.5263
2010
• ∆%PIB2000,2010 = 0.4545
Introduction GDP Other Variables

• Result depends on the base year chosen!

• 0.5263 vs 0.4545
• Reason: Prices act like weights
• In 2000 prices: Papple / Porange = 1,25
• In 2010 prices: Papple / Porange = 0,5
• The production of apples increased but the price of oranges
remained unchanged
• This is a problem with real GDP but it is still better than nominal GDP
• Real GDP grew using either base year while with nominal GDP it
decreased
Introduction GDP Other Variables

• Real GDP = nominal GDP in the base year (always)

• Nominal GDP 2000= 95; GDP2000
2000 = 95
• Nominal GDP 2010= 80: ; GDP2010
2010 = 80
• Reason?
• The calculations are the same (same price and quantity used,
verify!)
GDP Deflator
 The calculation of real GDP gives us a useful measure of 
inflation known as the GDP Deflator or GDP Implicit Price 
Index

 The GDP Deflator shows the change in the price level taking 
into account current physical output

GDP measured in current prices        
GDP Deflator =                       x 100
GDP measured in base year prices

© Gustavo Indart Slide 25
GDP Deflator 
January 1967 to September 2013

© Gustavo Indart Slide 26
Price Indexes
 The Consumer Price Index (CPI) shows the change in the price 
level taking into account a constant basket of consumer goods

Value of basket measured in current prices
CPI =                                                                                            x 100
Value of basket measured in prices of based period

 The Industrial Product Price Index (IPPI) is also a measure of the 
cost of a given basket of goods, but of intermediate goods 

© Gustavo Indart Slide 27
Consumer Price Index
December 1993 to September 2013

Source: Bank of Canada.

© Gustavo Indart Slide 28
 The Rate of Inflation
The inflation rate (π) is the percentage increase in the level of
prices during a given period:
P − P-1
π=
P-1
where P is the current price level and P-1 is the price level at
the end of the previous period.

© Gustavo Indart Slide 4

Main Differences between the CPI 
and the GDP Deflator
 The GDP deflator measures the prices of all goods and 
services produced in the economy, while the CPI measures 
the prices of only the goods and services bought by 
consumers

 The GDP deflator includes only goods and services produced 
domestically, while the CPI includes the prices of goods and 
services both produced domestically and imported

 The GDP deflator allows the basket of goods and services to 
change over time as the composition of GDP changes, while 
CPI considers a relatively more constant basket of goods and 
services
© Gustavo Indart Slide 29
Introduction GDP Other Variables

• Employment (N) ≡ number of people with jobs (over age of 15)

• Unemployment (U) ≡ number of people currently without a job and
actively seeking one (over age of 15)
• How to determine people not employed but seeking
employment?
• People registered at unemployment office
• Active population ≡ sum of N and U
• u=U/L ≡ unemployment rate
• (1-u) ≡ employment rate
Introduction GDP Other Variables

• Inactive population: people not included in active population

• People under 15
• Students
• Adults : Home makers, retirees, sick or those not looking for
employment
• Participation rate: Active population divided by people over 15 years of
age
• underemployed: Person looking for work with more hours
Introduction GDP Other Variables

• Discouraged workers (Trabajadores desanimados) : People who have

given up looking for work
• Are considered inactive
• Increases in unemployment are usually acompanied with an
increase in discouraged workers (decreases participation rate)
Introduction GDP Other Variables
Introduction GDP Other Variables
Introduction GDP Other Variables

• Why are economists concerned with unemployment?

• Welfare of unemployed is directly affected
• Represents that potentially economy is not using its resources
effectively
Introduction GDP Other Variables

• Can the unemployment rate be too low? YES!

• An economy can be using its resources excessively (Bubble)
• Can cause a shortage of labour in certain key industries
• The natural rate of unemployment is optimal uN
Introduction GDP Other Variables

Types of Unemployment
• Structural
• Frictional
• Cyclical