MACROECONOMICS

N. GREGORY MANKIW
MARK P. TAYLOR

Chapter 2:
The Data of
Macroeconomics

Prepared by
Ron Cronovich and
Emanuel Kohlscheen
Adapted by Marrit van den Berg
 Learning objectives
In this chapter, you will learn about:
• Gross Domestic Product (GDP) real
vs nominal
• the Consumer Price Index (CPI)
• the Unemployment Rate

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 Gross Domestic Product

Two definitions:

Total expenditure on domestically-
produced final goods and services

Total income earned by domestically-
located factors of production

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 The Circular Flow

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 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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 Real GDP controls for inflation
Changes in nominal GDP can be due to:
• changes in prices
• changes in quantities of output produced

Changes in real GDP can only be due to

changes in quantities,
because real GDP is constructed using
constant base-year prices.

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 Practice problem, part 1
2001 2002 2003
P Q P Q P Q
Butter €30 900 €31 1,000 €36 1,050

Guns €100 192 €102 200 €100 205

• Compute nominal GDP in each year

• Compute real GDP in each year using
2001 as the base year.

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 Answers to practice problem,
part 1
• Nominal GDP multiply Ps & Qs from same year
2001: €46,200 = €30 × 900 + €100 × 192
2002: €51,400
2003: €58,300

• Real GDP multiply each year’s Qs by 2001 Ps

2001: €46,300
2002: €50,000
2003: €52,000 = €30 × 1050 + €100 × 205

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 Real & Nominal GDP in the
UK: 1948-2004
1400
1200
1000
billion of £

800
600
400
200
0
48

54

60

66

72

78

84

90

96

02
19

19

19

19

19

19

19

19

19

20
Nominal GDP Real GDP (2002 prices)

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 Relative GDP per capita of EU Members
PPP adjusted: 2004 (EU average=100)
Austria 122.8 Netherlands 124.5 Latvia 42.9

Belgium 118.5 Portugal 72.2 f Lithuania 47.9

Denmark 121.3 Spain 97.7 f Malta 69.2

Finland 112.4 Sweden 117.5 Poland 48.9

France 109.4 UK 116.4 Slovakia 51.9

Germany 108.8 Slovenia 79.2

Greece 81.5 Cyprus 83.3

Ireland 137.2 Czech R. 70.4 U.S.A. 150.7

Italy 103.0 f Estonia 51.3 Japan 109.7 f

Luxembourg 226.4 f Hungary 60.2 Switzerland 131.5 f

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 GDP Deflator

• The inflation rate is the percentage

increase in the overall level of prices.
• One measure of the price level is
the GDP Deflator, defined as

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 Practice problem, part 2
Nom. Real GDP inflation
GDP GDP deflator rate
2001 €46,200 €46,200 n.a.
2002 51,400 50,000
2003 58,300 52,000
• Use your previous answers to compute
the GDP deflator in each year.
• Use GDP deflator to compute the inflation rate
from 2001 to 2002, and from 2002 to 2003.
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Answers to practice problem,
part 2

Nom. Real GDP inflation

GDP GDP deflator rate
2001 €46,200 €46,200 100.0 n.a.
2002 51,400 50,000 102.8 2.8%
2003 58,300 52,000 112.1 9.1%

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 Understanding the GDP deflator
Example with 3 goods
For good i = 1, 2, 3
Pit = the market price of good i in month t
Qit = the quantity of good i produced in
month t
NGDPt = Nominal GDP in month t
RGDPt = Real GDP in month t

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 Understanding the GDP deflator

The GDP deflator is a weighted average of

prices.
The weight on each price reflects
that good’s relative importance in GDP.
Note that the weights change over time.
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 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.
• This makes chain-weighted GDP more
accurate than constant-price GDP.
• But the two measures are highly correlated,
and constant-price real GDP is easier to
compute…
• …so we’ll usually use constant-price real
GDP.

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 Harmonized Index of
Consumer Prices (HICP)
• A measure of the overall level of prices
• Published by Eurostat, based on the
different national statistical institutes’ data
• Used to:
– track changes in the typical household’s
cost of living
– adjust contracts for inflation
– allow comparisons of Euro figures taken
from different years
– assess the degree of convergence of
inflation rates for Eurozone countries
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 How the HICPs are computed

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

Every month, collect data on prices
of all items in the basket; compute
cost of basket

CPI in any month equals:

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 Inflation Across the EU in 2004
Luxembourg
Spain
Greece
Portugal
Austria
Italy
Ireland
France
Germany
Belgium
United Kingdom
Netherlands Eurozone: 2.4%
Finland

0 1 2 3 4

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 Exercise: Compute the CPI
The basket contains 20 pizzas and
10 compact discs.

prices: For each year, compute:

pizza CDs • the cost of the basket
2000 €10 €15 • the CPI (use 2000 as
2001 €11 €15 the base year)
2002 €12 €16 • the inflation rate from
2003 €13 €15 the preceding year

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 Answers:

cost of inflation
basket CPI rate
2000 €350 100.0 n.a.
2001 370 105.7 5.7%
2002 400 114.3 8.1%
2003 410 117.1 2.5%

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 The composition of the HICP
“basket” in the UK
Food and bev. 2.5% 13.9%
1.7%
Clothing
15.7%
Housing

Apparel 15.1%
Transportation

Medical care

Recreation 10.6%
2.4%
Education

Communication
14.8% 6.3%
Hotels, cafes

Other 6.5% 10.5%

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 The composition of the HICP
“basket” in Spain
Food and bev. 1.7% 3.2% 14.8%
Clothing 6.9%
Housing 2.7% 8.3%
Transportation

Medical care

Recreation 14.6%
Education

Communication 22.0%
Hotels, cafes
10.8%
Other 9.2%
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 Understanding the CPI
Example with 3 goods
For good i = 1, 2, 3
Ci = the amount of good i in the CPI’s
basket
Pit = the price of good i in month t
Et = the cost of the CPI basket in month t
Eb = cost of the basket in the base period

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 Understanding the CPI

The CPI is a weighted average of prices.

The weight on each price reflects
that good’s relative importance in the HICP’s
basket.
Note that the weights remain fixed over time.
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 Reasons why
the CPI may overstate inflation
• Substitution bias: The CPI uses fixed weights,
so it cannot reflect consumers’ ability to substitute
toward goods whose relative prices have fallen.
• Introduction of new goods: The introduction of
new goods makes consumers better off and, in
effect, increases the real value of money. But it
does not reduce the CPI, because the CPI uses
fixed weights.
• Unmeasured changes in quality:
Quality improvements increase the value of money,
but are often not fully measured.
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 Discussion topic:
• If your grandmother receives a
pension, how is she affected by
the CPI bias?
• How does your grandmother’s
“basket” differ from the CPI’s?

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 CPI vs. GDP deflator
prices of capital goods
• included in GDP deflator (if produced
domestically)
• excluded from CPI

prices of imported consumer goods

• included in CPI
• excluded from GDP deflator

the basket of goods

• CPI: fixed (Laspeyes index)
• GDP deflator: changes every year (Paasche)
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 CPI vs. GDP deflator for the UK

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 Categories of the population
• employed
working at a paid job
• unemployed
not employed but looking for a job
• labour force
the amount of labour available for
producing goods and services; all
employed plus unemployed persons
• not in the labour force
not employed, not looking for work.
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Two important labour force
concepts
• unemployment rate
percentage of the labour force that is
unemployed
• labour force participation rate
the fraction of the adult population that
‘participates’ in the labour force

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 Exercise: Compute labour
force statistics
German adult population by group, 2003
Number employed = 35.8 million
Number unemployed = 3.8 million
Adult population = 82.5 million

Use the above data to calculate

• the labour force
• the number of people not in the labour force
• the labour force participation rate
• the unemployment rate

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 Answers:
• data: E = 35.8, U = 3.8, POP = 82.5
• labour force
L = E +U = 35.8 + 3.8 = 39.6
• not in labour force
NILF = POP – L = 82.5 – 39.6 = 42.9
• unemployment rate
U/L = 3.8/39.6 = 0.096 or 9.6%
• labour force participation rate
L/POP = 39.6/82.5 = 0.48 or 48%

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 Exercise: Compute percentage
changes in labour force statistics
Suppose
• the population increases by 1%
• the labour force increases by 3%
• the number of unemployed persons
increases by 2%

Compute the percentage changes in

the labour force participation rate: 2%
the unemployment rate: −1%
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 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.

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 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
• the GDP deflator, the ratio of nominal
to real GDP

The unemployment rate is the fraction of
the labour force that is not employed.
When unemployment rises, the growth rate
of real GDP falls.

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