Intro Macro                                                                 

Measuring Economic Activity:   National Income Accounting


Gross National Product (GNP):  The market value of current, final national production during a specific time interval, usual a year. The concept, "national" product, includes products made and income generated by extra-U.S. (outside the U.S. borders) property owned by U.S. citizens, and excludes products made and income generated by property in the U.S. that was owned by non-U.S. citizens.


           e.g.    IBM production abroad is include

Toyota production in the US is not included

Gross Domestic Product  (GDP):  production located within the national boundaries.  So, it includes production by foreigners. We don't care that New York's Rockefeller Center is owned by people who live in Japan--the services provided by Rockefeller Center to those who rent office space there, and the income generated by the rental are part of domestic product. Conversely, income generated abroad by factories located in Malaysia owned by U.S. citizens is not included in domestic product.


            e.g.      excludes IBMıs foreign production

                        includes Toyotaıs US production


US GDP was only slightly lower (1%) than GNP in the late 80's.  Recently, greater and greater emphasis has been placed on GDP than GNP since the level of foreign owned production within the US has risen. We now use domestic product because our estimates of cross-border income and profit flows are riddled with errors, and thus, our estimates of national product are of significantly lower quality than our estimates of domestic product.


Measuring GNP:

I.  Expenditure Approach:


GNP = personal consumption expenditure (PCE) + gross private domestic investment (GPDI)

         + government expenditures on goods and services (G) + net exports (NX)


Consider the following rough estimates which are representative of @1987

         A.  PCE:  66% of GNP

            (a)  durable goods:  goods which last a long time

            (b)  nondurable goods: consumed immediately such as food, clothing

            (c)  services:  entertainment, medical, legal etc.

         B.  GPDI:  16% of GNP

            (a)  nonresidential structures and equipment:  firmıs plants, equipment

            (b)  inventory investment:  firmıs net addition to inventory can be either positive or


            (c)  residential structures:  houses etc.


         C.  G:  20% of GNP

            (a)  federal

            (b)  state + local


         D.  NX:  -2.7% of GNP

            (a)  exports - imports


Shorthand:  GNP = C + I + G + (X - M)


Components of Expenditure Again:  we can now show the comparable data for GDP in 1995.


Consumption (rough estimates  as a percentage of GDP)

            services                        40%

            non-durables               20%    

            durable consumption     8%


Investment (rough estimates as a percentage of GDP)

            depreciation                                         9%

            net residential investment                     2%

            net non-residential investment             5%

            inventory investment                            1%      


Government  (rough estimates as a percentage of GDP)

            purchases of goods and services        17%


 Net Exports (rough estimates as a percentage of GDP):  -2%


Note Economists' peculiar definition of "investment": does not include capital gains (or losses) on property already existing. Focuses on tangible (physical) property.


Consider when Ford Motor Company "invented" the assembly line, and spent a lot of time and resources getting it to run smoothly. That kind of "investment" does not show up in the GDP accounts since it is not tangible, physical property, i.e., physical plant and equipment.



Observations about  Expenditure Approach

1.    Investment goods are not used up entirely  in production, thus they are not considered intermediate goods; they are final goods.


e.g.: iron ore and coke are used up entirely  in steel production so they are intermediate  goods, but the steel mill in which the production process occurs is not an intermediate good.  It is only partially used up in the process of making  other goods.  A steel mill may have a useful life of 40 years.  In producing steel in 1 year, only a small portion (say 1/40th) of the mill is consumed.  The ore and coking coal, on the other hand, are entirely consumed in producing steel. 


e.g.  A computer may have a useful working life of @4 years before it becomes obsolete.  The bank that uses the computer to manage its accounts also uses up only a portion (say 1/4th) of the computer in producing 1 yearıs banking services. Again, this using up of capital is called depreciation.  Depreciation is a business cost, just like labor costs or material costs. 


definition:  Depreciation is the value of the existing capital stock that has been  consumed in the process of producing output.  


Again, note that by gross we mean that investment is not adjusted for depreciation.  Thus, gross investment includes all the machines, factories, and houses built during a year even though some were bought simply to replace some old capital goods that were thrown on the scrap heap.  Therefore, to get a measure of the increase in societyıs capital, gross investment is not a sensible measure.  It excludes a necessary allowance for depreciation.  Hence, the Bureau of Economic Analysis (BEA) calculates net national product (NNP). 


Recall that,




It appears as though NNP is a sounder measure of a nation's output than GNP.  Including depreciation is like including the wheat as well as the bread.  So why do economists and journalists work with GNP?  Because it is available more quickly and is more reliable.  Estimating depreciation is perilous.  Thus, GDP or GNP is most often used because estimates of depreciation are poor.  In addition, more importantly, NNP and GNP move closely together over periods of a year or so.  A rule of thumb is that NNP is about 91% of GNP. 


2.    Why arenıt durable goods counted in investment?  Some economists argue that they should be.


3.    What about education expenditures?  They could be investment expenditures.


4.    Business expenditures of R and D,  management consulting etc, are counted as intermediate goods. Computers are an investment but software is considered an intermediate good. 


Net result: many economists consider investment to be underestimated.


5.    Note also that transfer payments are not included in G.


Definition of transfer payment:  no good or service provided by the recipient  for the money received.  They are a transfer of funds from the government to the household.


e.g. social security, welfare, government interest.


State and local governments make 60% of expenditures on goods and services (the federal government oversees many transfer payments)



6.    Why "net" exports?  When the government and households consume imports, we must later subtract them.


II.  Income Approach


            GNP = employee income                                            (payment to labor)

                     + proprietorıs income                                        (payment to business owner)

                     + rental income                                                  (includes rents, royalties)

                     + corporate profits

                     + net interest

                     + depreciation

                     + indirect business tax                                       (sales taxes)



Why make the definitions this way? So you can measure things a number of different ways. You can use accounting identities to check that things add up.

Thus, GDP is identical no matter which approach we take by definition.


Note the link between aggregate output and aggregate income.  The only way aggregate income can increase is if aggregate output increases so the two are used interchangeably.


What do households have to spend?


GNP - depreciation = Net National Product


NNP - indirect business taxes = National Income


NI - corporate taxes (profit tax and payroll tax) + transfer payments (social security, welfare, government interest) = Personal Income (PI)


PI - personal taxes = Personal Disposable Income


              Households can spend their Personal Disposable Income (PDI)


What do households do with PDI? 


              Consume or save.



Measures of Savings


1.  Personal Savings = PDI - personal consumption expenditure.


2.  Private savings = Personal savings + business savings (retained earnings)


3.  National savings = private savings + government savings




Some numbers relating measures of output and income:



Nominal GNP vs. Real GNP


Nominal GNP:  Nominal current year output evaluated at current prices

Real GNP:  Real current year output evaluated at base year prices.


Using real GNP removes effects of inflation





Q beer

P beer

Q books

P books


Real (1992 prices)































Observations about GNP:


1.     Does not count all nonmarket production, especially household services performed by household member  for no pay.  Nonmarketed goods are exchanged through barter arrangements or acquired through do-it-yourself activities that would otherwise have been purchased in organized markets.


This makes cross country comparison problematic.  For example, the per capita GNP of the U.S. is @55 times that of Zaire.  While differences between the living standards of the two countries are great, the statistics overstate the differential in material well-being because more goods in Zaire are acquired outside of market transactions .


2.     Does not count the ³underground² economy, illegal activities like selling drugs, smuggling, and the like.  Also GNP excludes moonlighting where people donıt report the income.  No one knows for certain the $ volume of illegal market activities.  IRS places it at between  6 and 8 percent of legal GDP.


3.      Does not include the value of leisure.  The number of hours the average American works per year has declined substantially over the past 50 years.  Therefore, we have chosen toproduce asmaller flow of goods and services in return for more leisure.  Voluntary increases in leisure raises material well-being just as increases in goods and services.  Thus, GDP is dramatically understated.  In 1900 workers in manufacturing worked on average a 60-hour week.  By 1989, this had fallen to 40 hours per week.  So, if workers worked today as much as they did in 1900, personal income would be much higher than it actually is.  Since workers choose leisure over higher income, it must mean that they value leisure more so than the extra income.


4.  GNP does not measure well-being very accurately.  Does not say anything about income             distribution within economy and does not account  for externalities.


Prices and Inflation Measurement


price index:  current yearıs cost of a certain group of goods as a % of the cost of the same

                     goods in a base year.


1.  GNP deflator = (nominal GNP/ real GNP) x 100


                             1987 real GNP = 3820 billion


                              deflator = 4486/3820 x 100 = 117.4


rearranging the GNP deflator equation yields




³market basket²:  goods and services bought by the typical household


Before 1998 the market basket was based on a survey of consumer expenditure from 1982 to 1984. The BLS would conduct a survey of the 400 goods and services that made up the market basket each month and weights prices by proportion of market basket. The weights used were

                 20% food (in home, out of home)

                 30% housing (cost of housing including utilities, furnishing)

                 50% other (clothes, transportation, medical, entertainment)

Now the CPI has become much more detailed although the principle is the same. Today the BLS uses a 1993-1995 basket and retains the 1982-1984 as the reference base period. The basket contains about 80,000 goods and services. Please see your text pages 120-121 for more details.

Differences between GNP deflator and CPI


1.     GNP deflator uses all final goods and services in the economy.  CPI uses select group of consumer goods and services.


2.     GNP deflator uses current year proportions of goods and services.  CPI uses base period proportions of goods and services (base period is currently 1993-1995.  No allotment is made for changes in quantity demanded) to construct a consumer basket of about 80,000 items.  Every month the BLS sends out individuals to record the prices of these items in 50 major, urban centers.

The CPI and Beatniks

Beatniks are often maligned and misunderstood.





Instead of young roughs, they are better exemplified by introspection




Musical aspirations and self expression




Hanging out and being cool




Beatniks have reached iconic status with their own Wobbler.




If beatniks asked you to calculate inflation in the beatnik world, how would you construct a price index to accomplish that task?


Counter Culture Economics

Beatnik Price Index (measured like CPI)

Cost of 1987 Market Basket    


Q 1987



1987 prices

1988 prices

Jack Kerouac Books






Black beret and matching turtleneck

















(base year) price index 1987 52/52 x 100 = 100

                  price index 1988 68/52 x 100 = 130.8


Inflation Rate


inflation: prices generally rising

deflation:  prices generally falling

disinflation:  deceleration of inflation; prices are still rising but at a slower rate.






example:  GNP deflator1986 = 114.1

                 GNP deflator1987 = 117.4


1987 inflation rate = (117.4 - 114.1)/114.1 x 100 = 2.9%


use the same process (i.e. percentage change) whether using GNP deflator or CPI index.

inflation based on GNP deflator or CPI are similar but usually different numbers.  They do move in the same direction. 


Unemployment Measurement


unemployment rate = #unemployed/# in labor force


labor force:  all those officially classified as employed and all those officially classified as                     unemployed.


³unemployed² means:  a)  have no job but actively sought work in previous 4 weeks.

                                      b) currently available for work

                                      c)  laid off and waiting to be called back.

                                      d)  waiting to start a new job within 30 days.




A.  students (full-time), people at home caring for kids, retirees, institutionalized people,       and those choosing not to work are not part of the labor force.


      also discouraged workers who have  given up searching for a job are not counted as       unemployed.  So, sometimes the unemployment rate undercounts the unemployed.        This is especially true during prolonged recessions.


B. Some people are looking for work so that they may qualify for government programs but      arenıt interested in working.  This implies the unemployment rate overstates      unemployment. 


C.  Underemployed workers would like a full-time job but canıt get it.  They can only find      part-time work.  Thus, the unemployment rate understates the true rate of       unemployment.



Four types of unemployment: represent differing degrees of voluntariness


1.  Frictional Unemployment: new workers entering labor force and people moving between jobs: primarily voluntary and an inevitable part of a dynamic economy, usually of short duration.


2.  Cyclical Unemployment: associated with downturns of the economy.  Involuntary, but usually temporary.


3.  Structural Unemployment: associated with long-run declines of certain industries (consumerıs tastes change, costs rise, technological change) e.g. smokestack industries.  Especially hard for older workers who cannot retrain or relocate as easily.


4.  Seasonal Unemployment: due to seasonal changes in employment or labor supply: farming, house building, skiing, and teenage unemployment in the summer. 





Labor Market Supply and Demand Model



A.  changes in W (the nominal wage) represent movements along DL

B.  shifts in DL


            a) changes in price of output - general price level

            b) changes in productivity - increasing education, increasing capital use

            c) changes in # of firms

            d) taxes paid by firms on wages



generally, as wages rise the labor supplied in the market increases (either more workers or more hours)


W0 is the reservation wage of worker L0


   ·   lowest wage at which a person is induced to accept  a job.  Equivalently, it is the opportunity cost of taking the job.  This varies across workers.

A.  wage changes represent movements along Ls

B.  shifting Ls

            a)  price of goods workers buy general price level

            b) change in worker preferences for work versus leisure

            c) size of labor force

            d) non-wage benefits

            e) taxes on wages



W* is the equilibrium wage.   At this wage, all who wish a job at the going wage have one.  No more workers want to work and firms do not want to hire more workers.


Workers 0 to Le are employed.  Workers Le to L are unemployed voluntarily.  Their reservation wage is higher than the market wage.

Example 1:  Consider an increase in productivity


An increase in productivity implies that the L0 workers are now worth more to the firm than they were before.  The quantity of labor demanded at each wage is now greater after the increase in worker productivity, than before. 

Prediction:  An increase in productivity implies that the wage rises and that the level of employment rises as well.  This fits the data fairly well.

1950s - 1960s:  increasing productivity and increasing wages

1970s - 1980s:  flat productivity and flat wages.

1990 s ­ 2000: flat continuing the trend of the previous two decades, yet something may have changed starting with the year 1996.  The US economy started experiencing more rapid growth and a lower natural rate of unemployment.  This could mean that the rate of growth in labor productivity is greater and will eventually show up in the form of a higher growth rate in the trend in real wages.

Example 2:  increase in the general price level (P)

Here both firms and workers expect that the price level is rising by the same amount.

Why does the wage rise, but the number of workers employed remain constant?

            W is the nominal wage which rises with the price level

            the real wage W/p, remains constant if %DW = %Dp



1)  p and W adjust at the same rate

2) %DW = %Dp

3)  perfectly flexible p and W. 

4)  firms and workers have the same information for forecasting price expectations.


Example 3:  tax on firms (e.g. unemployment benefits tax but ignoring payment of the benefits)


   ·   since firm canıt keep all the revenue guaranteed by the workerıs output after the tax is imposed, labor demand falls


   ·   each worker receives W1 (net wage)

      firm pays for each worker W2 (net wage plus tax)

effect:  the wage received by the worker falls and employment falls


incidence of the tax:  by which we mean who pays the tax, it is split between them

   ·   firms have to pay a higher gross wage.

   ·   workers receive lower net wage.


efficiency loss:  triangle  abc

firms would like to hire L1 - L0 workers, and workers would have value greater than the wage if hired.  But, the firm doesnıt hire the workers because of the tax


1)  tax causes decrease in demand

2)  gross wage is paid by firm

3)  net wage is received by worker

4)  tax = w2 - w1

5)  price level did not change, but the nominal wage received by workers decreased thus the       real wage fell.

6)  tax lowered the natural rate of employment


Job Search Model


1)  people should search longer in labor markets where there is a high variance in wages                    since the next job will more than likely pay a higher wage.

2)  people should not search long in markets with low wage variance.


The longer a worker searches, on average, the higher will be the wage offer.



the longer a worker searches, on average the lower will the reservation wage be b/c worker savings is depleted while searching and unemployment benefits expire. 


   ·   The intersection of the two curves gives the equilibrium wage and equilibrium duration of unemployment


   ·   The duration of unemployment and the unemployment rate rate tend to rise together (this is empirically true for the US)


Example 1:  Consider an increase in worker productivity





·      A productivity increase implies that the wage offer curve shifts up and to the left since firms are willing to pay more for each worker.


·      This means that the duration of unemployment goes down.


·      This analysis can be used to justify job-training programs to increase worker productivity thereby decreasing unemployment. 


·      Both the supply and demand model and the search mode predict the same result.






Example 2:  Payment of government unemployment benefits (ignore unemployment taxes)

reservation wage increases because not as costly to be unemployed which implies the wage increases which implies that the duration of unemployment rises and firms on average end up paying a higher wage.