Macro 101: what are GDP, unemployment rate, and inflation?
Before laying the foundation of our first model, there are some variables and concepts you should get to know. Let me introduce you to some macroeconomic variables that will accompany us throughout any articles dealing with economics.
- Aggregate output (GDP)
- Unemployment rate
- Inflation rate
The aggregate output
The aggregate output is the value of the goods and services produced within a country and is estimated in several ways. Since they are accounting identities, they bring the same result regardless of the method used.
. Production side: the value of final goods and services produced within an economy. Final goods are goods not used in intermediate processes (an example of intermediate good is the wood sold by a company to another that will use it to create a table)
. Income side: the overall value of all the incomes (wages, profits) distributed by resident producer units (e.g.factories) in the economy.
. Expenditure side: the sum of the value of goods and services demanded by the national economy, subtracting the imports and adding the exports.
The GDP can be either nominal or real; The nominal GDP ($Y) is calculated considering the face value of goods and services produced. Thus an increase in prices (without an actual change in production) will also lead to a growth in the nominal GDP.
On the other hand, using the real GDP (Y), the quantities of goods are evaluated at constant prices of an arbitrary base year.
Ex. Suppose that the Italian economy produces only mozzarella cheese.
As depicted in the table above, the nominal GDP is not functional to evaluate changes in the number of goods produced over time since prices can distort the overall picture. Therefore, it is possible to compute the real GDP (that considers inflation). Firstly, an arbitrary base year has to be selected: I will pick 2017 prices as a reference. Hence, real GDP will be:
So, we can measure the production at constant prices, making it easier to compare the values obtained. However, the real GDP has some downsides:
-It becomes less accurate moving away from the base year
-Changing the base year implies a change in the level of the real GDP
There are other methods, such as the method applied by the ESA 2010, that avoid this issue and enable a better cross-year comparison.
The unemployment rate (u)
Before giving you a broader overview of the labor market, I will introduce you to three main concepts:
-Unemployed (U); They actively look for a job without being able to find it. They belong to the labor force.
-Inactive; People who do not have a job and are not looking for it. They are outside of the labor force.
-Employed (N); All the employed belonging to the labor force.
The following scheme outlines the essential concepts needed to analyze the labor market.
As you can notice from the concentric sets, the working age population is a share of the total population. The labor force is a subset of the working-age population: the labor force is the sum of employed and unemployed (L=N+U) individuals. Therefore, the difference between the working-age population and the labor force is that the former includes inactive individuals.
There are two essential metrics:
-the participation rate (p); it is the ratio between the labor force (L) and the working-age population (P15–65).
-the unemployment rate (u); is a crucial metric we will discuss thoroughly in the following articles; it is the ratio between the unemployed individuals and the labor force.
However, it is not always true that a decrease in the rate of unemployment corresponds to an increase in employed individuals. All else constant, a decline in the unemployment rate may be related to unemployed individuals either dropping out of the labor force or finding a job. In the former case, the decrease in the unemployment rate is undesirable since it is caused by a drop in the labor force (fewer people look for work while many others become inactive or old. Therefore, the ratio U/(U+N) gets smaller); in the latter case, the reduction in unemployment is a positive sign for the economy (increase in the number of employed, so U/(U+N) decreases since the denominator does not change while the numerator decreases).
A snapshot of the Italian labor market
According to Eurostat, the Italian population accounted for 59,236 thousand people in 2021, and it has been declining since 2015. In 2021 the people aged between 15 and 65 years old corresponded to 63% of the population, a figure aligned with other western countries. However, according to the world bank, people over 65 years old accounted for 24% of the total population (just behind Japan with 29%), and people under 15 years represented just 13% of the citizens; This has several implications that cannot be discussed here for practical reasons. Since the active population amounted to 24,197 thousand people in the year 2021, the participation rate is:
Lastly, the unemployment rate is the difference between the labor force and the employed individuals, divided by the labor force:
This is one of the lowest figures in recent times. Nevertheless, the interpretation of the unemployment rate must consider the participation rate and other factors such as the structure of the labor market.
The unemployment rate over time
The graph above depicts the change in the unemployment rate over a thirty-year timespan in the USA and Italy. Remarkably, the American unemployment rate is generally lower, but it is also more volatile than the Italian (and European) one (look at the Covid crisis in 2020). This phenomenon is due to the regulation of the labor market, which in the USA is more dynamic with the drawback that it grants less protection to workers. On the other hand, Europe provides for broader protection of job places. Thus, the labor market in Europe is less responsive to economic shocks than the American labor market.
The inflation rate and the deflator
The inflation rate is the percentage change of prices over a specific period. In periods with negative inflation rates, we talk about deflation.
By introducing the concept of GDP deflator, we can draft a relationship between the nominal GDP, the real GDP, and the inflation rate. To compute the deflator for a given year it is necessary to choose a base year in which the real and the nominal GDP will coincide. In fact, the deflator in the year t is:
The nominal GDP is obtained by multiplying back the deflator for the real GDP. The deflator corresponding to the base year is always equal to one since the nominal and real GDP are equal. While the deflator by itself has no practical interpretation, the percentage change of the deflator from year t-1 to year t represents the inflation rate:
The following graph gives you an idea about the inflation levels in western countries over time.
As you can see from the graph above, the inflation rate in western countries has been moderate for almost thirty years, but it has been experiencing higher figures since the end of 2020. This shift may be related to several reasons that will be partly discussed in the following articles.
Although these topics are a piece of cake for many, it was essential for me to explain them thoroughly; Having a comprehensive understanding of these concepts is key to analyzing our complex world!
Hey! I am a student passionate about what I am doing. English is not my mother tongue, and one of the reasons why I am writing in a foreign language is to get better at it; feel free to make me aware of any mistakes. Any suggestion or comment on the topics dealt with is appreciated as well!
