Unit 2: The Data of Macroeconomics

Question 1

You should be familiar with the following key terms before you proceed to Unit 3. Activities to review these terms are available as part of the unit review.
gross domestic product (GDP)
consumption
investment
government purchases
net exports
nominal GDP
real GDP
GDP deflator
consumer price index (CPI)
inflation (deflation)
core inflation
indexation
nominal interest rate
real interest rate

Question 2

GDP

Answer 2

Gross Domestic Product:
Official definition is…
the market value of all final goods and services produced within a country in a given period of time.

EVERY WORD MATTERS IN THIS DEFINITION.

the total income of everyone in the economy

the total income of a nation

thought to be the best single measure of a society’s economic well-being and thus it is closely watched

-measures two things:
1. total income of everyone in the economy
2. total expenditure on the economy’s output of goods and services

For an economy as a whole, income must equal expenditure. Every transaction has two parties: a buyer and a seller.

Always shown as an annual rate, even if it is measured quarterly. Seasonally adjusted as well, so the rate may not look like what actually happened that season.

-macroeconomic

Question 3

inflation/deflation

Answer 3

the rate at which average prices are rising or falling

-macroeconomic

Question 4

unemployment

Answer 4

the percentage of the labour force that is out of work

-macroeconomic

Question 5

retail sales

Answer 5

total spending at stores

-macroeconomic

Question 6

trade deficit

Answer 6

the imbalance of trade between Canada and the rest of the world

-macroeconomic

Question 7

Examples of macroeconomics:

Answer 7

• GDP
• Inflation/deflation
• Unemployment
• Retail sales
• Trade deficit
• Why is the average income high in some countries while it is low in others?
• Why do prices rise rapidly in one time period but are more stable in another?
• What can the government do to promote growth in incomes, have low inflation, and have stable employment?

Question 8

markets for factors of production enable households to receive what from firms? (this gets passed on to households)

Answer 8

-wages
-rent
-profit (dividends)

Question 9

Markets for factors of production enable firms to receive what from households?

Answer 9

• labour
• land
• capital

Question 10

Things that are not included in GDP

Answer 10

• home-grown vegetables
• drugs produced and sold illicitly
• doing things for your partner who is married to you
• one person sells a used car to another person (do not include transactions involving items produced in the past)
• a Canadian working in Haiti does not contribute to Canada’s GDP (but does to Haiti)

So GDP can underestimate the true amount of productive activity taking place in the economy

Question 11

What are the four components of GDP?

Answer 11

consumption (C)
investment (I)
government purchases (G)
net exports (NX)

Y = C + I + G + NX is the GDP identity

Y stands for GDP

Question 12

identity

Answer 12

an equation that must be true by the way the variables in the equation are defined

Question 13

consumption

Answer 13

spending by households on goods and services

e.g. spending on postsecondary education is a consumption of services

Question 14

investment

Answer 14

the purchase of goods that will be used in the future to produce more goods and services

sum of purchases of:
- capital equipment
- inventories
- structures (new housing)

not just stocks, bonds, and mutual funds

Question 15

government purchases

Answer 15

spending on goods and services by local, territorial, provincial, and federal governments

e.g. salaries of government workers; spending on public works

does not include transfer payments such as paying the Canada Pension Plan to the elderly

Question 16

transfer payment

Answer 16

a payment not made in exchange for a currently produced good or service

they alter household income

they do not reflect the economy’s production

Question 17

net exports

Answer 17

exports minus imports

basically add a negative value for imports so that you can cancel them out from where the imports were included in the consumption, investment, and government purchases categories

GDP does not count foreign-made stuff!

Question 18

2018 GDP

Answer 18

$2,225,000,000,000

$2225 billion

$2.225 trillion

that’s $60 212 per person (using the population of 37 million)

Question 19

real GDP

Answer 19

The production of goods and services valued at constant prices.

Measures the value of goods and services produced in a year if they were valued at previous prices in the past.

This allows economists to figure out if the economy is producing a larger output of goods or if the goods are just being sold at higher prices for example. Economists need to be able to know which of these are occuring but measuring total spending from one year to the next could signify one, the other, or both. So we use real GDP to figure out what is going on.

By evaluating current production using prices that are fixed at past levels, real GDP shows how the economy’s overall production of goods and services changes over time. Real GDP is not affeted by changes in prices and reflect only the amounts being produced.

A better measure of economic well-being than nominal GDP. GDP usually measured as real GDP and you should assume this when GDP is reported.

The real GDP grows over time. But sometimes it drops and this is called a recession, usually shown with shaded bars over those time period domains on a line graph. We are not supposed to call it a recession until there have been two consecutive quarters of falling real GDP.

Question 20

nominal GDP

Answer 20

The production of goods and services valued at current prices.

Question 21

GDP deflator

Answer 21

GDP deflator = (nominal GDP / real GDP)*100

the base year always has a GDP of 100

The GDP deflator for subsequent years measures the change in nominal GDP from the base year that cannot be attibutable to a change in real GDP.

The GDP deflator measures the current level of prices relative to the level of prices in the base year. For example, if quantities produced stay the same from year to year but the prices rise, then nominal GDP will rise but real GDP will stay the same, so the deflator will also rise.

Used to measure the average level of prices in the economy.

Question 22

inflation rate

Answer 22

The percentage change in some measure of the price level from one period to the next.

inflation rate in year 3 = ((GDP deflator in year 3 - GDP deflator in year 2) / GDP deflator in year 2)*100%

E.g. 2016 was 100, 2017 was 171, 2018 was 240
so inflation rate in 2017 =( (171-100)/100)*100%
= 71 percent

and inflation rate in 2018 = ((240-171)/171)*100%
= 40 %

Question 23

consumer price index

Answer 23

Measures the overall cost of goods and services bought by a typical consumer.

Statistics Canada computes this figure monthly.

Similar to the GDP deflator but not the same.

Uses data on prices of over 600 goods and services chosen by analyzing what people normally buy (statistics canada does the math to figure this out).

CPI = (price of basket of goods and services in the current year / price of basket in base year)*100%

You can compute the inflation rate similarly to the GDP deflator method, just using CPI instead of GDP deflator:

inflation rate in year 3 = ((CPI year 3 - CPI year 2)/CPI year 2)*100 %

used to monitor changes in the cost of living over time

If the consumer price index rises, the typical family has to spend more dollars to maintain the same standard of living

changes dollar figures into meaningful measures of purchasing power

Question 24

core inflation

Answer 24

A measure of the underlying trend of inflation

This excludes the most volatile components from the CPI basket of goods and services such as fruit, vegetables, gasoline, fuel oil, natural gas, mortgage interest, intercity transportation, and tobacco products (19% of the CPI basket!)

It is supposed to be useful in predicting the underlying trend of inflation as measured by changes in the consumer price index.

Question 25

commodity substitution bias

Answer 25

consumers will buy less of the goods whose prices have risen by large amounts and more of the goods where prices have fallen, and the bias comes from the fact that we compute price indexes off a fixed basket of goods

cost of living is thus overstated

Statistics Canada will update the basket every 4 years recognizing that this is a problem, but the bias remains within each four year period.

Question 26

introduction of new goods

Answer 26

consumers do not always purchase the same goods, for example if new ones are created. A fixed basket does not account for this.

Increased set of choices makes each dollar more valuable.

Question 27

unmeasured quality change

Answer 27

It is challenging for Statistics Canada to measure a quality change, and thus if quality deteriorates then the value of the dollar falls and vise versa. Stats Canada tries to measure this change but it is so subjective that there are problems with the measurement.

Question 28

What are the three main reasons that CPI is overstated by aout 0.5% per year?

Answer 28

1. commodity substitution bias
2. introduction of new goods
3. unmeasured quality change

Question 29

How is the GDP deflator different at measuring inflation compared to CPI ?

Answer 29

They usually tell a similar story.

But:

• GDP reflects goods and services produced domestically (so Volkswagens are made in Germany and not part of GDP) whereas CPI measures goods and services bought by consumers (so CPI is a basket of goods for consumers, and doesn’t include armoured vehicles bought by the military) so the armoured vehicle would be included in the GDP but not the CPI, and the German vehicles would be included in CPI but not GDP.
• CPI is a fixed basket of goods, but GDP is looking at currently produced goods so this can have some difference

The two measures of inflation generally move together but you will see that the slope is sometimes more severe on one compared to the other.

Question 30

formula to change dollar figures from a past year into today’s dollar

Answer 30

amount in today’s dollars = amount in a past year dollars * price level today / price level in a past year

This is a simple conversion factor

CPI measures the price level and thus you can use the CPI for the price level today and price level in a past year

Question 31

indexation

Answer 31

the automatic correction of a dollar amount for the effects of inflation by law or contract

Question 32

stopped at chapter 6.2 page 129 (by the way you only have to get to 6.3 to finish the chapter and the unit so you are almost there!)