### chapter 2

```N. Gregory Mankiw
PowerPoint® Slides by Ron Cronovich
2
The Science of Macroeconomics
(edited by L. Lamb, 2011)
2010 UPDATE
CHAPTER
SEVENTH EDITION
MACROECONOMICS
In this chapter, you will learn:
…the meaning and measurement of the
most important macroeconomic statistics:
 2.1 Gross Domestic Product (GDP)
 2.2 The Consumer Price Index (CPI)
 2.3. The unemployment rate
2.1 Gross Domestic Product:
Expenditure and Income
Two ways to look at GDP:
 Total expenditure on domestically-produced
final goods and services.
 Total income earned by domestically-located
factors of production.
Expenditure equals income because
every dollar spent by a buyer
becomes income to the seller.
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The Circular Flow
Income (\$)
Labor
Firms
Households
Goods
Expenditure (\$)
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The value of output minus
the value of the intermediate goods
used to produce that output
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Final goods, value added, and GDP
 GDP = value of final goods produced
= sum of value added at all stages
of production.
 The value of the final goods already includes the
value of the intermediate goods,
so including intermediate and final goods in GDP
would be double-counting.
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Table 2.1 GDP and the Components of Expenditure: 2008
Mankiw and Scarth: Macroeconomics, Canadian Fourth Edition
Worth Publishers
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The expenditure components of GDP




consumption, C
investment, I
government spending, G
net exports, NX
An important identity:
Y
=
value of
total output
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C + I + G + NX
aggregate
expenditure
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Consumption (C)
definition: The value of all
goods and services bought
by households. Includes:
 durable goods
 nondurable goods
 services
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Investment (I)
 Spending on goods bought for future use
(i.e., capital goods)
 Includes:
 Residential fixed investment
 Inventory investment
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Investment vs. Capital
Note: Investment is spending on new capital.
Example (assumes no depreciation):
 January 1, 2012:
economy has \$500b worth of capital
 during 2012:
investment = \$60b
 January 1, 2013:
economy will have \$560b worth of capital
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Government spending (G)
 G includes all government spending on goods
and services.
 G excludes transfer payments
because they do not represent spending on
goods and services.
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NOW YOU TRY:
An expenditure-output puzzle?
Suppose a firm:
 produces \$10 million worth of final goods
 only sells \$9 million worth
Does this violate the
expenditure = output identity?
GNP vs. GDP
 Gross National Product (GNP):
Total income earned by the nation’s factors of
production, regardless of where located
 Gross Domestic Product (GDP):
Total income earned by domestically-located
factors of production, regardless of nationality
GNP – GDP = factor payments from abroad
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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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GDP Deflator
 Inflation rate: the percentage increase in the
overall level of prices
 One measure of the price level: GDP deflator
Definition:
Nominal GDP
GDP deflator = 100 
Real GDP
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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,
so it is more accurate than constant-price GDP.
constant-price real GDP, because:
 the two measures are highly correlated.
 constant-price real GDP is easier to compute.
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2.2 Consumer Price Index (CPI)
 A measure of the overall level of prices
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How CPI is constructed
1. Survey consumers to determine composition of
the typical consumer’s “basket” of goods
2. Every month, collect data on prices of all items
3. CPI in any month equals
Cost of basket in that month
100 
Cost of basket in base period
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Why the CPI may overstate inflation
 Substitution bias
 Introduction of new goods
 Unmeasured changes in quality
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Figure 2.3 The Inflation Rate as Measured
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2.3 Measuring Joblessness:
Categories of the population
 employed
 unemployed
 labor force
 not in the labor force
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Figure 2.4 The Three Groups of the Population
Mankiw and Scarth: Macroeconomics, Canadian Fourth Edition
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Two important labor force concepts
 unemployment rate
 labor force participation rate
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Figure 2.5 Okun’s Law
Mankiw and Scarth: Macroeconomics, Canadian Fourth Edition
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2.4 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.
 GDP is the sum of consumption, investment,
government purchases, and net exports.
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, or
 the GDP deflator,
the ratio of nominal to real GDP
 The unemployment rate is the fraction of the
labor force that is not employed.
Homework
End of chapter 2 in textbook:
Questions for review: 1,2,3,4
Problems & Applications: 2, 3, 4, 6, 7, 8 & 9
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