Macroeconomics

Chapter 2:
The Measurement and Structure of the
National Economy

ECON2220 Intermediate Macroeconomics

Wataru Miyamoto
Spring 2024

Copyright © 2024 Pearson Education Ltd. 1

Chapter Outline
• Goal: Measuring economic activity

• National income accounting

• The measurement of production, income, and expenditure
• Gross Domestic Product
• Saving and Wealth
• Real GDP, price indexes, and inflation
• Interest rates

2
National Income Accounting
• National income accounts: an accounting framework used in
measuring current economic activity
• Common systems and measures used worldwide

• Goal: Understanding
• how much people produce
• how much people receive as income
• how much people spend

3
Gross Domestic Product
• Aggregate measure of quantities produced

• GDP (gross domestic product) is the

• (1)market value of
• (2)final goods and services
• (3)newly produced within a nation during a fixed period of time

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Gross Domestic Product
• (1)Market value: allows adding together different items by valuing
them at their market prices
• 10 apples and 10 oranges…how can we add up? We use prices in markets

• Problem: misses nonmarket items such as homemaking, housework, the

value of environmental quality, and natural resource depletion

• Government services (that aren’t sold in markets) are valued at their cost of
production

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Gross Domestic Product
• (2)Final goods and services
• Don’t count intermediate goods and services (those used up in the
production of other goods and services in the same period that they
themselves were produced) to avoid double counting

• Final goods & services are those that are not intermediate

• Company A: produces oranges and sells them to Company B (100$)

• Company B: sells orange juice to consumers (200$), buying oranges from
Company A (100$)

• Final goods = Orange juice

• Intermediate goods = Orange

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Gross Domestic Product
• Important concept to compute GDP
• Value added = value of output minus value of inputs purchased from other
producers

• Same example
• Company A: produces oranges and sells them to Company B (100$)
• Company B: sells orange juice to consumers (200$), buying oranges from
Company A (100$)

• GDP = Final goods

= 200$
= (200$ - 100$) + 100$
= Value added by Company B + Value added by Company A
= Sum of value added

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Gross Domestic Product
• (2)Final goods and services
• Consumption goods
• E.g. orange juice

• Capital goods (goods used to produce other goods) are final goods since they
aren’t used up in the same period that they are produced
• E.g. juice mixer

• Inventory investment (the amount that inventories of unsold finished goods,

goods in process, and raw materials have changed during the period) is also
treated as a final good
• E.g. oranges

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Gross Domestic Product
• (3)Newly produced: counts only things produced in the given period;
excludes things produced earlier

• Oranges produced last year and sold for consumption this year (100$)
• GDP last year and this year?

• Oranges produced last year (100$) and sold to produce orange juice this year
(200$)
• GDP last year and this year?

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Gross Domestic Product
• GNP vs. GDP
• GNP (gross national product) = output produced by domestically owned
factors of production
• E.g. labor, capital (factory)

• GDP = output produced within a nation

• GDP=GNP-NFP
• NFP = net factor payments from abroad
• Payments to domestically owned factors located abroad minus payments to
domestically located foreign factors

• Difference between GNP and GDP is small for the United States, about 0.2%,
but higher for countries that have many citizens working abroad
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Gross Domestic Product
• GNP vs. GDP
• You go to the US and produce oranges there (100$)
• GDP and GNP for Hong Kong?
• GDP and GNP for the US?

• Your company (HK) buys oranges from the US (100$) and produces orange
juice in Hong Kong (200$)
• GDP and GNP for Hong Kong?
• GDP and GNP for the US?

• Gross vs. Net

• Depreciation (the value of capital that wears out in the period)
• Your produced orange juice using a juice mixer (10000$)
• The juice mixer (1000$) broke
• GDP?
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Gross Domestic Product
• Q: What happens to US GDP when
• I buy a new Tesla car
• I buy a used Tesla car
• Hamburger buns bought by McDonald’s Corporation for making Big Macs
• I sell my IBM stocks for $1000
• I buy a piece of land to build a house
• GDP measures production
• Not included
• The sale of financial assets, such as stocks and bonds
• Sales of used goods
• Intermediate goods and services/inputs
• Goods and services produced outside Hong Kong

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Gross Domestic Product
• Three equivalent ways to calculate GDP
• (1)Product approach
• Add up value added of all producers
• E.g. GDP is the total amount of cookies produced in a year. Count the cookies
as they are made
• (2)Expenditure approach
• Add up all spending on domestically produced final goods and services
• E.g. GDP is the total amount of cookies sold in a year. Count the cookies as
they are sold to consumers.
• (3)Income approach
• Add up all income paid to factors of production
• E.g. GDP is the total income earned by employees of Starbucks plus the
profits made by Starbucks.
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Gross Domestic Product
• Why are the three approaches equivalent?
• They must be, by definition
• Any output produced (product approach) is purchased by someone
(expenditure approach) and results in income to someone (income approach)

• The fundamental identity of national income accounting:

total production = total income = total expenditure

• GDP is sometimes called output, income, or value added

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Gross Domestic Product
• The expenditure approach to measuring GDP
• Measures total spending on final goods and services produced within a nation
during a specified period of time

• Four main categories of spending:

• Consumption (C)
• Investment (I)
• Government purchases of goods and services (G)
• Net exports (NX)

𝑌𝑒𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋

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Gross Domestic Product
• Consumption
• Spending by domestic households on final goods and services (including those
produced abroad)
• About 2/3 of U.S. GDP

• Three categories
• Consumer durables (examples: cars, T V sets, furniture, major appliances)
• Nondurable goods (examples: food, clothing, fuel)
• Services (examples: education, health care, financial services, transportation)

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Gross Domestic Product
• Investment
• Spending for new capital goods (fixed investment) plus inventory investment
• i.e. Spending by firms on final goods and services
• Volatile, with fixed investment about 13% to 20% of U.S. GDP

• Business (or nonresidential) fixed investment: spending by businesses on

structures, equipment, and intellectual property products, such as software,
research and development, or artistic originals
• Residential fixed investment: spending on the construction of houses and
apartment buildings
• Inventory investment: increases in firms’ inventory holdings

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Gross Domestic Product
• Economic investment vs financial investment
• Financial investment
• Purchase of stocks, bonds, and other financial assets
• Purchase generally transfers ownership of a portion of the firm’s existing
capital stock
• Does not correspond to any increase in physical capital or production
capacity, in most cases

• Economic investment: the increase in the capital goods used to

produce other goods
• Expenditure on value added

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Gross Domestic Product
• Government purchases of goods and services
• Spending by the government on goods or services
• About 20% of U.S. GDP
• Not all government expenditures are purchases of goods and services
• Some are payments that are not made in exchange for current goods and
services
• One type is transfers, including Social Security payments, welfare, and
unemployment benefits
• Another type is interest payments on the government debt
• Some government spending is for capital goods that add to the nation’s capital
stock, such as highways, airports, bridges, and water and sewer systems

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Gross Domestic Product
• Net exports:
• Exports minus imports
• Exports: goods produced in the country that are purchased by foreigners
• Imports: goods produced abroad that are purchased by residents in the
country
• Imports are subtracted from GDP, as they represent goods produced abroad,
and were included in consumption, investment, and government purchases

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Figure: Expenditure Approach to Measuring GDP in the
United States

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Figure: Expenditure Approach to Measuring GDP in
Hong Kong
100%

80%

60%

40%

20%

0%

-20%
1965

2007
1961
1963

1967
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005

2009
2011
2013
2015
2017
Net exports Consumption Investment Government purchases
22
Table 2.1: Expenditure Approach to Measuring GDP in
the United States, 2021
Billions of dollars Percent of G D P
Personal consumption expenditures (C) 15,750 68.5
Consumer durables 2025 8.8
Nondurable goods 3457 15.0
Services 10,269 44.7
Gross private domestic investment (I) 4108 17.9
Business fixed investment 3051 13.3
Nonresidential structures 579 2.5
Equipment 1273 5.5
Intellectual property products 1200 5.2
Residential investment 1083 4.7
Inventory investment - 26 - 0.1

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Table 2.1: Expenditure Approach to Measuring GDP in
the United States, 2021
Billions of dollars Percent of G D P
Government purchases of goods and services 4052 17.6
(G)
Federal 1565 6.8
National defense 905 3.9
Nondefense 660 2.9
State and local 2487 10.8
Net exports (N X) - 916 - 4.0
Exports 2480 10.8
Imports 3396 14.8
Total (equals G D P) (Y) 22,994 100.0

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Gross Domestic Product
• The income approach to measuring GDP
• Adds up income generated by production (including profits and taxes paid to
the government)
• National income =
compensation of employees (including benefits)
+proprietors’ income
+ rental income of persons
+ corporate profits
+ net interest
+ taxes on production and imports
+ business current transfer payments
+ current surplus of government enterprises
• Roughly, Wage + Interest + Rent + Profit + Tax

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Gross Domestic Product
• The income approach to measuring GDP
• National income
+ depreciation (the value of capital that wears out in the period)
= gross national product (GNP)
• GNP − net factor payments (NFP) = GDP

26
Table 2.2: Income Approach to Measuring GDP in the
United States, 2021
Billions of dollars Percent of G D P
Compensation of employees 12,581 54.7

Proprietor’s income 1822 7.9

Rental income of persons 726 3.2

Corporate profits 2806 12.2

Net interest 686 3.0
Taxes on production and imports 1148 5.0
Business current transfer payments 164 0.7
Current surplus of government enterprises - 13 - 0.1
Total (equals National Income) 19,920 86.6

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Table 2.2: Income Approach to Measuring GDP in the
United States, 2021
Billions of dollars Percent of GDP
Plus Statistical discrepancy - 520 - 2.3
Equals Net National Product 19,401 84.4
Plus Consumption of fixed capital 3848 16.7
Equals Gross National Product (G N P) 23,249 101.1
Less Factor income received from rest of world 1145 5.0

Plus Payments of factor income to rest of 893 3.9

world
Equals Gross Domestic Product (G D P ) 22,996 100.0

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Gross Domestic Product
• Private sector and government sector income
• Private disposable income
= income of the private sector
= private sector income earned at home (Y or GDP) and abroad (NFP)
+ payments from the government sector (transfers, TR , and interest on
government debt, INT)
− taxes paid to government (T)
= 𝑌 + 𝑁𝐹𝑃 + 𝑇𝑅 + 𝐼𝑁𝑇 − 𝑇

• Government’s net income

= taxes-transfers-interest payments
= 𝑇 − 𝑇𝑅 − 𝐼𝑁𝑇

Private disposable income + government’s net income

= 𝐺𝑁𝑃 = 𝐺𝐷𝑃 + 𝑁𝐹𝑃
29
Gross Domestic Product
• Questions
• You consume oranges produced in the US (100$)
• GDP? Which expenditure component?

• Your company produced oranges but could not sell this year
• GDP? Which expenditure component?

• Your company sells oranges to the US company

• GDP? Which expenditure component?

• Output = Expenditure = Income

• Why? By definition!
• If you cannot sell oranges, we treat them as inventory investment by you and
the expenditure is treated as income you made

30
Gross Domestic Product
• Notice we want to measure economic activity/well-being
• Calculating GDP is one way to do that
• Problems of GDP
• Non-market transactions
• Housework (home production)
• Taking care of babies by yourself vs hiring a nanny, cooking at home vs eating
outside
• Informal sector
• Drug trade (illegal, tax avoidance)
• Environmental problem
• Air pollution
• Natural resource depletion
• May use up natural resource to produce goods

31
Gross Domestic Product
• Problem of GDP
• May not reflect the standard of living
• Natural disaster
• May increase GDP
• Wealth
• Assets (accumulated capital, natural resource etc.) vs income each year
• Value of public goods
• Using public parks for free vs private parks
• Overwork
• Disutility from working
• Inequality, political environment, etc.
• Mismeasurement
• Estimates, revised later
• Manipulation by a government

32
Figure: US GDP revisions, 1993-2015

33
Figure: Argentina’s real GDP, official and non-
official estimates

34
Gross Domestic Product
• Does GDP reflect the standard of living?
• Stevenson and Wolfers (2008):
“Economic Growth and Subjective Well-Being: Reassessing the Easterlin
Paradox”
https://www.nber.org/papers/w14282.pdf

• Surveys about subjective happiness and GDP

• e.g. To what degree are you satisfied with your life now? (1. Satisfied 2.
Somewhat satisfied 3. Somewhat dissatisfied…)

35
Figure: GDP and Life Satisfaction

36
GDP and Life Satisfaction
• GDP and life satisfaction are positively correlated
• Caution: This does not necessarily mean the increase in GDP leads to higher
life satisfaction
• Why not?
• Other factors may affect both GDP and life satisfaction (Omitted variable bias)
• Causation may run from life satisfaction to GDP (Reverse causality)

• Correlation vs Causation
• Higher exam score & sitting in the first row
• Causation? Omitted variable bias/reverse causality?
• The number of seeing a doctor and health

37
Saving and Wealth
• Wealth
• So far, we focused on income in a year/quarter
• But can we measure economic well-being only from income (i.e. salary) in a
year/quarter?
• Wealth (accumulation of saving) is also important

• Household wealth = a household’s assets minus its liabilities

• National wealth = sum of all households’, firms’, and governments’ wealth
within the nation

• Savings by individuals, businesses, and government determine wealth

38
Saving and Wealth
• Measures of aggregate saving
• Saving ≡ current income − current spending/needs

• Aggregate saving = private saving + public saving

• Private saving (Households and firms)

• Household saving is done by families and individuals
• Business saving makes up the majority of private saving in the US
• Business saving is revenues less operating cost less dividends to shareholders

• Public saving (Government)

39
Saving and Wealth
• Private saving (Households + Firms)
= private disposable income – consumption

𝑆𝑝𝑣𝑡 = 𝑌 + 𝑁𝐹𝑃 − 𝑇 + 𝑇𝑅 + 𝐼𝑁𝑇 − 𝐶

• Tax (𝑇)
• Transfers (𝑇𝑅)
• Interest payments (𝐼𝑁𝑇)

• Current spending/needs exclude all investment

• Most consumption and government spending is for current needs. For
simplicity, we assume all of 𝐶 and 𝐺 are for current needs

40
Saving and Wealth
• Government saving
= net government income
– government purchases of goods and services

𝑆𝑔𝑜𝑣𝑡 = 𝑇 − 𝑇𝑅 − 𝐼𝑁𝑇 − 𝐺

• Tax revenue (𝑇)

• Government purchases of goods and services (𝐺)
• Transfers (𝑇𝑅)
• Interest payments on government debt (𝐼𝑁𝑇)

41
Saving and Wealth
• Measures of aggregate saving
• National saving
= private saving + government saving

𝑆 = 𝑆𝑝𝑣𝑡 + 𝑆𝑔𝑜𝑣𝑡
= 𝑌 + 𝑁𝐹𝑃 − 𝑇 + 𝑇𝑅 + 𝐼𝑁𝑇 − 𝐶
+ 𝑇 − 𝑇𝑅 − 𝐼𝑁𝑇 − 𝐺
= 𝑌 + 𝑁𝐹𝑃 − 𝐶 − 𝐺
= 𝐼 + 𝑁𝑋 + 𝑁𝐹𝑃 (∵ 𝑌 = 𝐶 + 𝐼 + 𝐺 + 𝑁𝑋)

42
Saving and Wealth
• The uses of national saving

𝑆 = 𝐼 + 𝑁𝑋 + 𝑁𝐹𝑃 = 𝐼 + 𝐶𝐴

• 𝐶𝐴 ≡ 𝑁𝑋 + 𝑁𝐹𝑃 : Current account balance

• If we assume a closed economy (𝑁𝑋 = 𝑁𝐹𝑃 = 0)

𝑆=𝐼

• Saving – investment spending identity

• National saving and investment spending are always equal for the economy as a
whole

43
Figure 2.2: Components of the U.S. uses-of-saving
identity, 1960Q1–2021Q4

44
Saving and Wealth
• Relating saving and wealth
• National wealth: domestic physical assets (+ net foreign assets)
• Country’s domestic physical assets (capital goods and land)
• Country’s net foreign assets
= foreign assets (foreign stocks, bonds, and capital goods owned by domestic
residents)
− foreign liabilities (domestic stocks, bonds, and capital goods owned by
foreigners)

• Changes in national wealth

• National saving (𝑆 = 𝐼 + 𝐶𝐴) raises wealth
• Change in value of existing assets and liabilities (change in price of financial
assets, or depreciation of capital goods)

45
Real GDP , Price Indexes, and Inflation
• Nominal GDP
• Nominal variables are those in dollar terms

• Problem: Do changes in nominal values reflect changes in prices or

quantities?
• 10 oranges, 10$ each this year: Nominal GDP = 100$
• 20 oranges, 10$ each next year: Nominal GDP=200$
• 10 oranges, 20$ each next year: Nominal GDP=200$

• Real variables: adjust for price changes; reflect only quantity changes
• Q: Which one do you care about, nominal or real GDP?
• We care about the changes in the number of oranges produced

46
Real GDP , Price Indexes, and Inflation
• Real GDP
• Nominal GDP is the dollar value of an economy’s final output measured at
current market prices (=Price of orange each year)

• Real GDP is an estimate of the value of an economy’s final output (quantities),

adjusting for changes in the overall price level
• We use the prices of a selected base year

• GDP deflator = 100 x nominal GDP/real GDP

• Calculate inflation rate:
𝑃𝑡 − 𝑃𝑡−1
𝜋𝑡 =
𝑃𝑡−1
4
𝑃𝑡
• Annualized inflation rate based on quarterly data: 𝜋𝑡 = −1
𝑃𝑡−1
𝑃𝑡 −𝑃𝑡−4
• Sometimes year-on-year inflation rate is used: 𝜋𝑡 =
𝑃𝑡−4

47
Real GDP , Price Indexes, and Inflation
• Real GDP
• If there is only one type of goods (e.g. orange), the calculation is simple
• Real GDP = the number of oranges
• Nominal GDP
= the number of oranges × price of orange
= HKD value of oranges
• GDP deflator = Nominal GDP / Real GDP
= Price of orange

• With multiple goods, the calculation is a bit more complicated as we want to

make a single measure for price level and real quantity
• Otherwise, we must track prices and quantities of all goods and sometimes hard
to see if prices and quantities are increasing overall

48
Real GDP , Price Indexes, and Inflation
• GDP deflator:
• 2017: 100x400/400 = 100 (Base year)
• 2018: 100x525/450 = 116
• 2019: 100x600/470 = 127
Apple Orange Nominal Real
GDP GDP
Year P Q P Q

2017 20 10 10 20 20x10+10x20=400 20x10+10x20=400

base
2018 25 10 11 25 25x10+11x25=525 20x10+10x25=450

2019 25 11 13 25 25x11+13x25=600 20x11+10x25=470

49
Figure 2.4: The inflation rate (GDP deflator) in the
United States, 1960–2021

50
 0.0
5.0

- 10.0
10.0
15.0
20.0

- 5.0
1962
1964
1966
1968
1970

• HK GDP Deflator
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Figure : The inflation rate (GDP deflator) in Hong Kong

51
Real GDP , Price Indexes, and Inflation
• Price Indexes
• A price index measures the average level of prices for some specified set of
goods and services, relative to the prices in a specified base year
• Consumer Price Index (CPI)
• Monthly index of consumer prices
• Want to measure the cost of living for households
• GDP deflator: Prices for all the goods produced including investment goods
• The CPI measures
• The cost of a standard basket of goods and services in a given year (updated
periodically)
• Relative to the cost of the same basket of goods and services in the base year

• Q: What kind of expenditure is important?

52
Figure: Composition of Basket for CPI

53
Real GDP , Price Indexes, and Inflation
• Consumer Price Index (CPI)
• How to compute
Cost of market basket in a given year
CPI =
Cost of market basket in a base year
• Example
• Base year basket: 1 apple and 1 orange
Year Apple Orange Cost CPI
(price) (price)
2018 10$ 5$ 10x1 + 5x1=15 15/15=1

2019 11$ 6$ 11x1 + 6x1=17 17/15=1.133

54
Real GDP , Price Indexes, and Inflation
• Problem of CPI
• Does CPI inflation overstate increases in the cost of living?
• The CPI was biased upward by as much as one to two percentage points per
year
• Two problems

• (1) One problem is that adjusting the price measures for changes in the
quality of goods is very difficult
• e.g. computers
• Better quality over time, firms charge higher prices
• Does this mean the cost of living is increasing over time?

55
Real GDP , Price Indexes, and Inflation
• Problem of CPI
• (2) Price indexes with fixed sets of goods (CPI) don’t reflect substitution by
consumers when one good becomes relatively cheaper than another

• This problem is known as substitution bias

• You consume apples and oranges
• Price of orange increases
• You may buy more apples
• However, CPI basket is fixed (unlike GDP deflator)

56
Figure: CPI and GDP deflator inflation rates in the US

57
Real GDP , Price Indexes, and Inflation
• Application: The Fed’s preferred inflation measures
• The Federal Reserve focuses its attention on the personal consumption
expenditures (PCE) price index
• Core PCE price index: PCE minus food and energy price

• The PCE price index is superior to the CPI because it avoids substitution bias
• The Fed uses the core PCE price index to measure the underlying trend in
inflation

58
Figure 2.5: Overall PCE inflation rate and core PCE
inflation rate, January 1960 to December 2021

59
Real GDP , Price Indexes, and Inflation
• Adjusting for inflation in general
• A nominal quantity is measured in terms of its current dollar value
• A real quantity is measured in physical terms
• Quantities of goods and services

• Why do we care about a real quantity?

• Why do we need to adjust?
• With some concerns about constructing price indexes

60
Real GDP , Price Indexes, and Inflation
• To compare values over time, use real quantities
• The values of 1 HKD today and last year are different.
• Ultimately, we care about how many oranges people produce.

• Deflating
• Divide a nominal quantity by its price index to get quantity in real terms
• E.g. Hourly wage was 100 HKD last year and is 110 HKD this year. The price level
was 100 last year and 110 this year. What is the real wage this year? What was
the real wage last year?
• Does this matter in reality? Look at the next figure.

61
Figure: Real vs Nominal Wages

62
Interest Rates
• Real vs. nominal interest rates
• Interest rate: a rate of return promised by a borrower to a lender
• Nominal interest rate: rate at which the nominal value of an asset increases
over time
• Real interest rate: rate at which the real value of an asset increases over time

• Q: Which do you care about, nominal or real interest rate?

• Nominal: You deposit 1 HKD, how much do you get back in HKD in a year?
• Real: You deposit 1 orange, how many oranges do you get back in a year?

63
Interest Rates
• Real vs. nominal interest rates
• Real interest rate = 𝑖 − 𝜋
𝑖 : Nominal interest rate, 𝜋 : Inflation rate
• e.g. 2% nominal interest rate and 1% inflation
Real interest rate = 2 - 1 = 1%
• Note: Exact calculation
• 100 HKD deposit becomes 102 HKD (2% interest rate)
• Price level changes from 100 to 101 (1% inflation)
• Real quantity changes from 100/100=1 to 102/101 (about 1% increase, this
approximation holds if 𝑖 and 𝜋 are close to 0)
• The expected real interest rate
𝑟 = 𝑖 − 𝜋𝑒
• We do not know inflation rate in advance
• If 𝜋 = 𝜋 𝑒 , real interest rate = expected real interest rate
64
Figure 2.6: Nominal and real interest rates in the United
States, 1960–2021

65
Interest Rates
• Real vs. nominal interest rates
• Sometimes the difference is quite large

• About 8 % nominal interest rates and 0 % real interest rates during 70s

66
Summary
• Goal: Measurement of economic activity
• GDP
• Market value, final goods, newly produced
• Output = Expenditure = Income
• Standard of living? Not perfectly
• Wealth
• Saving = Investment
• Nominal vs Real
• Ultimately, we care about real quantities
• Price indexes
• GDP deflator (fixed prices) and CPI (fixed basket)
• Quality and substitution bias
• Interest rate

67
Review: GDP by Expenditure
• Analyse the following events on each component of the GDP by
expenditure (C, I, G and NX).
1) A farm has produced $2,000 coffee beans. Then, a coffee shop purchased
the coffee beans and the coffee produced are sold at $6,000.

2) A manufacturer has sold a new television from the inventory from last year
for $5,000.

3) A local consumer has purchased clothes from a foreign retailer online for
$1,000.

68
Review: GDP by Expenditure
• Analyse the following events on each component of the GDP by
expenditure (C, I, G and NX).
1) A farm has produced $2,000 coffee beans. Then, a coffee shop purchased
the coffee beans and the coffee produced are sold at $6,000.

69
Review: GDP by Expenditure
• Analyse the following events on each component of the GDP by
expenditure (C, I, G and NX).
2) A manufacturer has sold a new television from the inventory from last year
for $5,000.

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Review: GDP by Expenditure
• Analyse the following events on each component of the GDP by
expenditure (C, I, G and NX).
3) A local consumer has purchased clothes from a foreign retailer online for
$1,000.

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Review: Interest Rates
• Suppose you want to buy a house and you need to borrow a
$1 million mortgage loan from a bank. The expected
inflation rate for this year is 2%.
1) If the bank wants to at least charge a real interest rate of 5%,
what should be the nominal interest rate?
2) If the actual inflation rate turns out to be 4%, do you benefit from
this unexpectedly high inflation rate? Why?

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Review: Interest Rates
• Suppose you want to buy a house and you need to borrow a
$1 million mortgage loan from a bank. The expected
inflation rate for this year is 2%.
1) If the bank wants to at least charge a real interest rate of 5%,
what should be the nominal interest rate?

• Real interest rate = Nominal interest rate – Expected inflation rate

• The bank should set the nominal interest rate at 5%+2% = 7%.

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Review: Interest Rates
• Suppose you want to buy a house and you need to borrow a
$1 million mortgage loan from a bank. The expected
inflation rate for this year is 2%.
2) If the actual inflation rate turns out to be 4%, do you benefit from
this unexpectedly high interest rate? Why?

• Actual real interest rate = Nominal interest rate – Actual inflation

rate
• Actual real interest rate = 7%-4% = 3%.
• Actual real interest rate (3%) is lower than expected real interest
rate (5%), so the borrower benefits from the unexpectedly high
inflation rate.

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