Week 1

Lectures 1 & 2

Measuring Macroeconomic Performance: Output

and Prices
Reference: Bernanke, Olekalns and Frank (BOF) Chapter 1
Key Issues
Indicators of macroeconomic performance
Measuring output (GDP)
Measuring prices and inflation

Evaluating Macroeconomic Performance

1. Rising Living Standards economic growth
Tendency for the level of output (i.e. quantity and quality
of goods and services) to increase over time.
Output divided by population = output per capita
May also care about the distribution of living standards

Dec-2014

Sep-2013

Jun-2012

Mar-2011

Dec-2009

Sep-2008

Jun-2007

Mar-2006

Dec-2004

Sep-2003

Jun-2002

Mar-2001

Dec-1999

Sep-1998

Jun-1997

Mar-1996

Dec-1994

Sep-1993

Jun-1992

Mar-1991

Dec-1989

Sep-1988

Jun-1987

Mar-1986

Dec-1984

Sep-1983

Jun-1982

Mar-1981

Dec-1979

Sep-1978

Jun-1977

Mar-1976

Dec-1974

Sep-1973

$, cvm

Real Quarterly GDP per-capita Australia (1973-2015)

18000

16000

14000

12000

10000

8000

6000

4000

2000

2. Stable Business Cycle low volatility in fluctuations

of actual output around its trend or potential output.
Australias Real Quarterly GDP Growth Rates Decade
Averages
1960s 1970s 1980s 1990s 2000s 2010s
Mean
1.25 0.83 0.84 0.84 0.77 0.63
Standard 1.50 1.42 1.09 0.79 0.52 0.38
Deviation
Ratio
0.83 0.58 0.77 1.06 1.48 1.66
Mid-1980s Great Moderation large fall in volatility of
real output why?

Australias Growth Rate vs. Volatility: Decade Averages

1.40

60s
1.20

Mean growth per qtr

1.00

80s

90s

0.80

70s

2000s
2010s

0.60

0.40

0.20

0.00

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

Std of quarterly growth

3. Relatively Stable Price Level low (positive) rate of

inflation
Inflation has been concern for most developed countries
over the last half century.
Japan is an exception and has experienced deflation
over the last decade.

10.0

5.0
Year-ended percentage change

Australian Inflation - Consumer Price Index Measure

20.0

15.0

0.0

Mar-2014
Mar-2011
Mar-2008
Mar-2005
Mar-2002
Mar-1999
Mar-1996
Mar-1993
Mar-1990
Mar-1987
Mar-1984
Mar-1981
Mar-1978
Mar-1975
Mar-1972
Mar-1969

Mar-1966
Mar-1963
Mar-1960
-5.0

4. Sustainable Levels of Public and National Debt

Public debt borrowing by public sector from private
sector
Influenced by government budget deficits/surpluses
Foreign debt borrowing by domestic residents from
foreign countries
Influenced by an economys current account
deficits/surpluses

5
Percent of GDP

Budget Balance and Net Government Debt for Australia

20

15

10

2017-18
2016-17
2015-16
2014-15
2013-14
2012-13
2011-12
2010-11

Net Debt
Budget Deficit (underlying)

2009-10
2008-09
2007-08

2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01
-5

-10

30
Percent

Australias Net External Liabilities (% of nominal GDP)

70

60

50

40

20

10

Mar-2014
Sep-2012
Mar-2011

Sep-2009
Mar-2008
Sep-2006
Mar-2005
Sep-2003
Mar-2002

Total
Equity
Debt

Sep-2000
Mar-1999

Sep-1997
Mar-1996
Sep-1994
Mar-1993
Sep-1991
Mar-1990
Sep-1988
-10

10

5. Balance between Current and Future

Consumption
How much should an economy save/invest?

11

I/Y
Mar-2015

Dec-2013

Sep-2012

Jun-2011

Mar-2010

Dec-2008

Sep-2007

Jun-2006

Mar-2005

Dec-2003

Sep-2002

Jun-2001

Mar-2000

Dec-1998

Sep-1997

Jun-1996

Mar-1995

Dec-1993

Sep-1992

Jun-1991

Mar-1990

Dec-1988

Sep-1987

Jun-1986

Mar-1985

Dec-1983

Sep-1982

Jun-1981

Mar-1980

Dec-1978

Sep-1977

Jun-1976

Mar-1975

Dec-1973

Sep-1972

Jun-1971

Mar-1970

Share of GDP

Australian Investment and National Saving

0.40

0.35

0.30

0.25

0.20

0.15

0.10

0.05

0.00

NS/Y

12

6. Full Employment
Provision of employment for all individuals seeking work

13

Feb-2015

Feb-2014

Feb-2013

Feb-2012

Feb-2011

Feb-2010

Feb-2009

Feb-2008

Feb-2007

Feb-2006

Feb-2005

Feb-2004

Feb-2003

Feb-2002

Feb-2001

Feb-2000

Feb-1999

Feb-1998

Feb-1997

Feb-1996

Feb-1995

Feb-1994

Feb-1993

Feb-1992

Feb-1991

Feb-1990

Feb-1989

Feb-1988

Feb-1987

Feb-1986

Feb-1985

Feb-1984

Feb-1983

Feb-1982

Feb-1981

Feb-1980

Feb-1979

Feb-1978

Percent

Australian Unemployment Rate Monthly

12.0

10.0

8.0

6.0

4.0

2.0

0.0

14

Measuring National or Aggregate Output

GDP = Gross Domestic Product

15

Which of the following is the correct definition of GDP?

(a)Value of all goods and services bought and sold
during a year
(b) Value of all new goods and services produced
during a year
(c) Value of all final goods and services purchased
during a year
(d) None of the above

16

GDP = Gross Domestic Product

Definition:
The market value of final goods and services produced
in a country during a given period.

17

The market value of final goods and services produced

in a country during a given period.
GDP is a flow variable measured over a period of time.
Quarter March, June, September, December
Australian GDP in March 2015 = $403.5 billion
Year just add-up GDP over 4 quarters
Calendar Mar-09 + Jun-09 + Sep-09 + Dec-09
Financial Sep-09 + Dec-09 + Mar-10 + Jun-10

18

The market value of final goods and services produced

in a country during a given period.
Excludes goods and services that are produced in
other countries (but might be consumed in Australia)
Imports
Excludes goods and services that were produced in
some earlier period, but are re-sold in the current
period second-hand goods

19

The market value of final goods and services produced

in a country during a given period.
GDP is measure of aggregate production or output
Use market prices to value (or weight) quantities of
various goods and services
Example:

Quantity
10 cars
100 apples

Market Price
$20,000 per car
$1 per apple

GDP = $200,000 + $100 = $200,100

20

What about goods and services with no observed

market price?
Some are included in GDP:
National defense use costs of provision (costs of
buying equipment, wages of soldiers, etc.)
Roads
Some are excluded from GDP
Unpaid housework (Household production)

21

The market value of final goods and services produced

in a country during a given period.
GDP excludes intermediate goods and services. These
goods are used-up in the production process.
Example: In the production of a loaf of bread, the flour
used is an intermediate input and is not (double)
counted in GDP.
Concept of Value Added: The market value of a firms
production less the cost of inputs purchased from other
firms

22

Value Added in Computer Sales: Chapter 1, Problem 2

(Textbook)
Firm
Added
Intel Incorp
Macro Soft
Bell
PC Charlies

Sales

Cost of inputs

20,000
5,000
80,000
100,000

0
0
25,000
80,000

Value
20,000
5,000
55,000
20,000

PC Charlies final sales = $100,000

Sum of Value Added = $100,000

23

The Verge Caf offers a big breakfast of bacon, eggs,

tomato and toast for $10. What is the best measure of
the value added of a big breakfast?
(a)$10
(b)$10 less the cost of the bacon, eggs, tomato and
toast
(c)$10 plus the cost of the bacon, eggs, tomato and
toast
(d)the cost to Verge Caf of purchasing the bacon, eggs,
tomato and toast
(e)$10 less the cost of the bacon eggs, tomato, toast
and the labour cost (waiter and cook) required to
produce the big breakfast
24

(a)$10 (contribution to GDP, not value added of big

breakfast at Verge Caf)
(b)$10 less the cost of the bacon, eggs, tomato and
toast (Yes, price less cost of intermediate inputs)
(c)$10 plus the cost of the bacon, eggs, tomato and
toast
(d) the cost to Verge Caf of purchasing the bacon,
eggs, tomato and toast (cost of intermediate inputs)
(e)$10 less the cost of the bacon eggs, tomato, toast
and the labour cost (waiter and cook) required to
produce the big breakfast (Labour cost is not
intermediate input)

25

3 Equivalent Ways to Measure GDP

1. Production Method
2. Expenditure Method
3. Income Method

26

Expenditure Method
Accounting Identity
Expenditure on goods and services by final users must
equal the value of their production.
Components of Expenditure
Consumption (C) purchases by Households
Investment (I) purchases by Firms
Government (G) Government purchases
Net Exports (NX ) net purchases by foreign
sector
NX = Exports (X) Imports (M)
27

National Income Accounting Identity

GDP=Expenditure
Y = C + I + G + NX
Y=C+I+G+XM
Y+M=C+I+G+X
Supply of G & S = Demand for G & S

28

Australian GDP March Quarter 2015

Expenditure Approach
$billion
Household Consumption
229.4
Private Investment
88.0
Government (Public) Spending
89.7
Change in Inventories
0.2
Exports
82.6
Less Imports
86.3
Total
403.6
Statistical discrepancy
-0.1
GDP
403.5
http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPa
ge/5206.0Mar%202015?OpenDocument
29

Income Method
GDP also equals the aggregate incomes paid to
Labour (L)
Capital (K)
in the production of goods and services.

GDP = Labour Income + Capital Income

30

Australian GDP March Quarter 2015

Income Approach
$billion
Compensation of Employees
192.7
Gross Operating Surplus
137.5
Gross Mixed Income
33.7
Total Factor Income
363.9
Taxes Subsidies
41.2
Total
405.1
Statistical discrepancy
-1.5
GDP (Market Prices)
403.5
http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPa
ge/5206.0Mar%202015?OpenDocument
31

Which of the following is the correct definition of GDP?

(a)Value of all goods and services bought and sold
during a year (This would include second-hand goods)
(b) Value of all new goods and services produced
during a year (This would include intermediate goods)
(c) Value of all final goods and services purchased
during a year (Option says purchased (not produced) so
includes imported goods and services)
(d) None of the above (Correct choice)

32

Nominal vs. Real GDP

Nominal
values quantities of goods and services produced
at current year prices

Real (or constant price or chain volume measure)

values quantities of goods and services produced
at base year prices measure of the actual
physical volume of production

33

Example
No. of Cars
Price of Cars
No. of Apples
Price of Apples
Nominal GDP

2007
10
$20,000
100
$1
$200,100

Real GDP
2007 prices
2008 prices

$200,100
$400,200

2008
% Change
10
0
$40,000
100
100
0
$2
100
$400,200
100

$200,100
$400,200

0
0

34

Choice of Base Year (Bit Technical)

In the above example whether we use 2007 or 2008 as
base year prices gives the same answer for the growth
rate of real GDP
This is not the case in general, particularly if you are
comparing real GDP over a 5-10 year period.
Using initial prices (i.e. 2007) is known as a
Laspeyres index
Using final prices (i.e. 2008) is known as a Paasche
index

35

Chain Weighting
For any two consecutive years compute the growth
rates of real GDP implied by both the Laspeyres and the
Paasche indexes.
Then take the average of the two growth rates and this
is the chain-weighted growth rate. This can be used to
compute a real chained-weighted GDP.
Finally to compute a change index over a long period,
the above approach is applied on a year-by-year basis.

36

Example
No. of Cars
Price of Cars
No. of Apples
Price of Apples
Nominal GDP

2007
10
$20,000
100
$10
$200,100

Real GDP
2007 prices
2008 prices

$200,100
$402,500

2008
% Change
10
0
$40,000
100
1000
900
$25
150
$425,000
112

$210,000
$425,000

4.9
5.6

37

Chain-weighted measure of Real GDP

Take average of growth rates implied by 2007 and 2008
prices.
5.25 = (4.9 + 5.6)/2
Choose either 2007 or 2008 as the base-year
(nominal=real GDP). Lets pick 2007
2007
Nominal GDP 200,100
Real GDP
200,100

2008
425,000
210,605 (200,1001.0525)

38

Chain Volume Measures of GDP and Components

RBA Website
http://www.rba.gov.au/statistics/tables/index.html#prices
_inflation
ABS Website
http://www.abs.gov.au/websitedbs/d3310114.nsf/Home/
Home?OpenDocument

39

Is GDP A Good Measure of Economic Wellbeing?

GDP per capita = GDP/Pop (see slides 2 and 3)
Omissions from GDP that might matter for economic
welfare
Leisure Time (extra week of holidays)
Household production (cook at home)
Environmental Degradation
Quality of Life (happiness)
Economic Inequality (distribution of income)

40

Is GDP positively correlated with economic welfare?

Yes: medical care
No:

Income distribution over last 20 years

Maybe: Income and measures of Happiness

41

Alternatives (complements) to GDP

1. Direct measures of Happiness
- Survey-based measures (ask people how happy
they are on a scale of 1 to 10.
http://www1.eur.nl/fsw/happiness/index.html

2. Indexes of variables that might affect welfare

http://www.smh.com.au/national/wellbeing-index-showsimpact-of-jobless-on-society-20140606-39okt.html
42

Measures of the Price Level

Want to measure the average level of prices in the
economy.
Main Measures
Consumer Price Index (CPI)
GDP Deflator/Price Index
CPI For a given period, measures the cost in that
period of a given basket of goods and services relative
to their cost in a fixed year called a base year.

43

Construct a CPI
Choose a basket of goods and services
Basket
2000 (base)
Rent (2 bedroom flat)
$500
Hamburgers (60)
$150
Books (2)
$30
Total Expenditure
$680

2015
$630
$150
$70
$850

CPI =
Cost of base-year basket of goods and services in
current year
Cost of base-year basket of goods and services in base
year
CPI = $850/$680 = 1.25
44

 Cost of living is 25 percent higher in 2015 than it was

in 2000
Average prices are 25 percent higher in 2015 than in
2000
Australian CPI
Published quarterly by ABS
Household Expenditure Survey used to determine
typical basket
Base year changes every 5 years

45

Was Charles Dickens the Taylor Swift of the 19th

Century?
According to a recent biography of the 19th century
novelist Charles Dickens, in 1862 he could earn 190
pounds per night for giving a reading from his novels.
According to The Richest (website) Taylor Swift earns
revenue of about US $1.2 million from a concert.
What information would you need to be able to calculate
what Dickens earnings are in current UK pounds?
http://www.measuringworth.com/calculators/ppoweruk/
46

Inflation (and Deflation)

Inflation is measured by the percentage change in the
CPI over a given period.
Inflation rate

CPI CPI (1)

= [ CPI (1) ] *100

Inflation rate = 0 implies prices are constant

Inflation rate > 0 implies prices are rising
Inflation rate < 0 implies prices are falling Deflation

47

Limitations with CPI

Quality Adjustment and New Goods Bias
Quality improvements may show up as higher
prices for goods and services
New goods are often not included until CPI is rebased
Substitution Bias
Use of a fixed basket means that no allowance is
made for consumers substitution toward
relatively less expensive goods.
CPI tends to overstate the rate of inflation.
48

Costs of Inflation
Important to distinguish between relative price
change and a change in the general price level
Shoe-leather costs inflation reduces the real
purchasing power of a given amount of money
Menu costs real costs of changing prices
Introduces noise into the price mechanism
Distorts tax systems (if not indexed to inflation)
Unexpected re-distributions of wealth

49

Inflation and Interest Rates

Nominal Interest Rates percentage increase in the
nominal (or dollar) value of a financial asset.
Real Interest Rate percentage increase in the real
purchasing power of a financial asset.

r i
r = real interest rate
i = nominal interest rate
= inflation rate

50

Fisher Effect
Nominal interest rate = real rate + (expected)
inflation rate

i r

51

8.0
Percent

Inflation and Nominal Interest Rate

18.0

16.0

14.0

12.0

10.0

6.0

4.0

2.0

0.0

Sep-2014
Mar-2013
Sep-2011
Mar-2010
Sep-2008
Mar-2007
Sep-2005

Mar-2004
Sep-2002
Mar-2001
Sep-1999
Mar-1998

Sep-1996

Inflation rate (year-ended)

10 year bond rate

Mar-1995
Sep-1993
Mar-1992
Sep-1990

Mar-1989
Sep-1987
Mar-1986
Sep-1984
Mar-1983

Sep-1981
Mar-1980
-2.0

52

The nominal interest rate on a one year government

bond is 8 percent per annum. Investors require an
annual real return of 3 percent. What is the
expected rate of inflation?
(i)
(ii)
(iii)
(iv)
(v)

11 percent
8 percent
5 percent
3 percent
Insufficient information to calculate

53

The nominal interest rate on a one year government

bond is 8 percent per annum. Investors require an
annual real return of 3 percent. What is the
expected rate of inflation?
(i) 11 percent
(ii) 8 percent
(iii) 5 percent
(iv) 3 percent
(v) Insufficient information to calculate
Use Fisher effect

= +
= = 8 3
54