Data in Macroeconomics

The Scarcity Principle

Boundless wants cannot be satisfied
with limited resources.
Therefore, having more of one thing
usually means having less of another.
Because of scarcity we must make
choices.
 Three Problems All Economic
Systems Must Address
What should be produced?
How should it be produced?
For whom will it be produced?
 Microeconomics
The study of individual choice under
scarcity and its implications for the
behavior of prices and quantities in
individual markets
Macroeconomics
The study of the performance of
national economies, and of the policies
that governments use to try to improve
that performance
 Gross Domestic Product (GDP)
The market value of the final goods and
services produced in a country during a
given period
The Circular Flow
Income
($)
Labor

Household Firms
s

Goods

Expenditure
($)
 Market Value
Market value is used to aggregate the quantities of
different goods and services into one measurement
Calculating GDP for
Total production = 4 apples, 6 bananas, and 3 pairs of
shoes
Price of apples = INR 0.25
Price of bananas = INR 0.50
Price of shoes = INR 20
Calculating GDP for Orchardia
GDP
(4 x INR 0.25) + (6 x INR 0.50) + (3 x INR 20) = INR 64
 Produced Within a Country During a
Given Period
Given Period
Counts only goods produced during the
defined period such as a calendar year
Examples
The sale of used goods is not counted.
Real estate commissions are counted.
 Produced Within a Country During a
Given Period
Domestic
Only production that takes place within a
countrys border
Examples
Cars produced in India by foreign owned
companies are counted.
Cars produced in Europe by Indian owned
companies are not counted.
 Final Goods or Services
Goods or services consumed by the
ultimate user; because they are the end
products of the production process, they
are counted as part of GDP
Intermediate Goods or Services
Goods or services used up in the
production of final goods and services
and therefore not counted as part of
GDP
 Final Goods and Services
Bread Production
Milling Co. pays INR 0.50 for wheat
Bakery pays INR 1.20 for flour
Bakery sells bread for INR 2.00
Contribution to GDP = INR 2.00
 Value Added
For any firm, the market value of its
product or service minus the cost of
inputs purchased from other firms
 Value Added in Bread Production

Company Revenues Cost of purchased inputs = Value added

ABC Grain INR 0.50 INR 0.00 INR 0.50

General Flour INR 1.20 INR 0.50 INR 0.70
HotnFresh INR 2.00 INR 1.20 INR 0.80
Total INR2.00

The grain and flour are produced in 2005

Bread is produced in 2006
INR1.20 is added to 2005 GDP
INR0.80 is added to 2006 GDP
 GVA (basic prices) includes production
taxes but excludes per unit product taxes
Production tax: does not depend on
quantum of output
Examples: Stamp and registration fees
Product taxes: per-unit taxes
Examples: excise, customs, service sales
GDP (factor cost) excludes both production
and product taxes
The expenditure components of GDP

consumption, C
investment, I
government spending, G
net exports, NX
An important identity:
Y = C + I + G + NX

value of
aggregate
total
expenditure
 Contribution to GDP
2007-08 2008-09 2009-10 2010-11 2011-12 2012-13

Agriculture 16.81 15.77 14.64 14.45 14.1 13.69

Industry 20.65 20.14 20.43 20.32 19.64 18.94

Services 62.54 64.1 64.94 65.23 66.25 67.41

Source: RBI
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.
 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.
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.
Your textbook usually uses
constant-price real GDP, because:
 Comparing real GDP across
countries
Purchasing power parity P=EPF
In reality P<EPF
Overstate the GDP of developed
countries and understate it for
developing countries
In order to compare real GDP across
countries multiply the nominal GDP
by PF/P
 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
Understanding the GDP
deflatorExample 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
Understanding the GDP
deflator
NGDPt P1t Q1t P2t Q2t P3t Q3t
GDP deflatort
RGDPt RGDPt

Q1t Q2t Q 3t
P1t P2t P3t
RGDPt RGDP t RGDP
t

The GDP deflator is a weighted average

of prices.
The weight on each price reflects
that goods relative importance in GDP.
Note that the weights change over time.
 How the CPI is constructed
1. Survey consumers to determine
composition of the typical
consumers basket of goods
2. Collect data on prices of all items in
the basket; compute cost of basket
3. CPI in any
Costmonth equals
of basket in that month
100
Cost of basket in base period
NOW YOU TRY:
Compute the CPI
Basket: 20 pizzas, 10 compact discs

prices: For each year,

pizza CDs compute
2002 Rs10 the cost of the
Rs15 basket
2003 Rs11 the CPI (use 2002 as
Rs15 the base year)
2004 Rs12 the inflation rate
Rs16 from the preceding
2005 Rs13 year
Rs15
NOW YOU TRY:
Answers to CPI exercise
Cost of Inflation
basket CPI rate
2002 $350 100.0 n.a.
2003 370 105.7 5.7%
2004 400 114.3 8.1%
2005 410 117.1 2.5%
 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 the dollar. But it
does not reduce the CPI, because the CPI
uses fixed weights.
Unmeasured changes in quality:
Quality improvements increase the value of
 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
GDP deflator: changes every year
 The WPI is considered as the headline inflation
measure because of its availability at high frequency
While the WPI does not cover prices of services, CPIs
are meant to reflect the cost of living conditions for a
homogeneous group of consumers based on retail
prices.
Among the four measures of CPI, the CPI for Industrial
workers (IW) has a broader coverage than the others
the CPI for agricultural laborers (AL), rural laborers
(RL) and urban non-manual employees (UNME).
In the organized sector, CPI-IW is used as a cost of
living index.
 GDP deflator, on the other hand, is a
comprehensive measure of inflation,
implicitly derived from national accounts
data as a ratio of GDP at current prices to
constant prices.
While it encompasses the entire spectrum
of economic activities including services,
it is available on a quarterly basis with a
lag of two months since 1996.
What is Inflation?
No direct housing weightage in WPI
CPI VS WPI
Divergence between WPI
and CPI
They differ in terms of their weighting
pattern. First, food has a larger weight in
CPI ranging from 46 per cent in CPI-IW to 69
per cent in CPI-AL whereas it has a weight
of only 27 per cent in WPI.
Second, the fuel group has a much higher
weight in the WPI (14.2 per cent) than the
CPIs (5.5 to 8.4 per cent). As a result,
movement in international crude prices has
a greater bearing on WPI than on the CPIs.
 Third, services are not covered under
WPI while they are, to different
degrees, covered under CPIs.
Consequently, service price inflation
has a greater influence on CPIs.
Notwithstanding the long-run lead-
lag relationship, the divergence
between WPI and CPI has
accentuated since early 2008
 Another way to analyze inflation data is by
looking at core inflation, which is
generally a chosen measure of inflation
that excludes the more volatile categories,
such as food and energy prices.
The main argument here is that the
central bank should be responding to the
movements in permanent components of
the price level rather than temporary
deviations.
 In Indian context, the derivation of
core inflation by exclusion of food and
energy from CPI/WPI discards a
substantial portion of the commodity
basket.
So the price movement of the
remaining commodities may not be
representative of the underlying
inflationary trend.