The Iowa Electronic Markets

Macroeconomic Conditions: Measurement and Political Implications

Economics Curriculum Using the IEM

Presidential and Congressional Control Markets

September, 2000

Learning Objectives

Macroeconomic Conditions: Measurement and Political Implications

Module Summary

This module summarizes the relationship between macroeconomic conditions and national elections. Students will learn how economic data provide important information about the state of the economy, how to measure a variety of economic indicators, and how these indicators are related to national elections. In addition, students will apply their skills in using economic indicators to forecast election results and compare their results to other forecasting methods (polls, Iowa Electronic Markets) as well as actual election outcomes.

Prior to implementing this module, instructors should:

  • Obtain and read the background information on Ray Fair’s Vote Predictions Model

Source: fairmodel.econ.yale.edu/vote (with links to articles and the model)

  • Be familiar with the Iowa Electronic Markets Vote-Share Market (and/or Congressional Control Market)

Sources:

(1)biz.uiowa.edu/iem/news.html (articles on the vote-share market, e.g. see Business Week, November 11, 1996; Business Week, October 9, 2000);

(2)biz.uiowa.edu/iem/about.html (e.g. see Wall Street Journal, August 28, 1995)

Prior to this module, students should:

  • Be able to access the Web, go to specific Web sites, and download data
  • Be familiar with use of Excel spreadsheets to record data, compute simple algebraic functions (percent change), and graph results.

Learning Objectives

At the end of this module, students should be able to:

  • identify and understand the importance of basic indicators of national economic conditions.
  • obtain, utilize, and interpret macroeconomic data used to summarize national economic conditions.
  • understand and explain how national economic indicators are measured and used to summarize and describe economic conditions.
  • understand the relationship between national economic conditions and the outcome of national elections.
  • understand how the IEM political markets are used to predict national elections and how they differ from other election-prediction tools (e.g. polls and economic models)
  • explain how accurately the Iowa Electronic Markets ( IEM) political markets have predicted past national election outcomes relative to economic models and public opinion polls (focus on 2000 presidential election)
  • (Optional, when presidential markets are open) apply the knowledge about macroeconomic indicators and the economic data to trade in IEM political markets.

Lecture Outline

Macroeconomic Conditions: Measurement and Political Implications

  1. Motivation
  1. Does the Government Affect the Economy?

1)Government spending as % of GDP

  1. Does the Economy Affect the Government?

1.)Do macroeconomic conditions influence national elections?

2.)Political quotes from past presidential elections

  1. How do we Determine the Condition of the Economy?
  1. Measuring Macroeconomic Conditions

1.)Inflation

2.)Unemployment

3.)Economic Growth

4.)International Trade

  1. Four Questions

1)How do we measure these?

2)How well is the economy performing according to these measures?

3)How does economic performance influence national elections?

4)What influences economic performance?

  1. Measuring Economic Activity
  1. Inflation

1.)Definitions: CPI and Inflation Rate

2.)Formula: Inflation Rate

  1. Unemployment

1.)Definition: Unemployment Rate

2.)Formulas

  1. Economic Growth

1.)Definition: Growth Rate of Per Capita Real GDP

2.)Formulas

  1. International Trade

1.)Definition: Current Account Balance

2.)Formulas

  1. Economic Performance: The Historical Experience
  1. The Historical Experience: 1959-1999
  2. How are we doing today relative to the historical experience?
  1. Does Economic Performance Affect National Elections?
  1. Three tools

1.)Public Opinion Polls

2.)Iowa Electronic Markets

3.)Economic Models

a.)Fairmodel

b.Presidential Election 2000 Predictions (Oct. 1, 2000 Predictions)

1.)Polls (actual clippings)

2.)IEM (screen shot)

3.)FairModel (calculate/show the equation)

c.Analysis

1.)How close were the three predictions to the actual results?

2.)Why were there prediction errors? What is missing?

a.)Microeconomic factors

b.)Other macroeconomic factors

  1. Extension: Predicting Congressional Outcomes
  1. Lewis-Beck Model
  2. IEM Congressional Control Market
    Lecture Notes

Macroeconomic Conditions: Measurement and Political Implications

Lecture notes are included as part of the Powerpoint presentation.

Powerpoint Slides

Macroeconomic Conditions: Measurement and Political Implications

See attached Powerpoint slides.

Assignment 1

Economic Indicators and Measuring Economic Activity

Assignment Overview and Objectives:

Statistics on the unemployment rate, inflation rate, and real GDP provide information on economic conditions in the nation. These statistics are often called “economic indicators” because of their ability to “indicate” the overall health of the economy. In this assignment, you will learn how to obtain data on various measures of economic activity and calculate additional economic indicators based on this data.

Assignment:

Use tables A and B on the following pages to complete this exercise.

  1. Obtain quarterly nominal GDP data (NGDP) (billions of $) from the first quarter of 1996 (1996:Q1) through the fourth quarter of 2000 (2000:Q4) from the St. Louis Federal Reserve Bank’s Federal Reserve Economic Data (FRED) Web site ( Enter this data in the second column of Table A below.
  1. Obtain quarterly real GDP data (RGDP) (billions of chained 1996 $) from the first quarter of 1996 (1996:Q1) through the fourth quarter of 2000 (2000:Q4) from the St. Louis Federal Reserve Bank’s Federal Reserve Economic Data (FRED) Web site. Enter this data in the third column of Table A and the second column of Table B below.
  1. Calculate quarterly values for the GDP Deflator (DEF) by dividing nominal GDP by real GDP for each quarter and multiplying the resulting value by 100. Enter these values in the fourth column of Table A below.

Example: to calculate the GDP deflator for the first quarter of 1996:

  1. Calculate the growth rate of the GDP deflator (the inflation rate) as the percentage change in the value of the GDP deflator from one quarter to the next and enter this data in the fifth column of Table A below.

Example: to calculate the percentage change in the value of the GDP deflator for the second quarter of 1996:

  1. Obtain monthly U.S. population data (POP) from January, 1996 (1996:1) through December, 2000 (2000:12) from the St. Louis Federal Reserve Bank’s Federal Reserve Economic Data (FRED) Web site . Convert this monthly data to quarterly data by computing the quarterly average of the monthly data and fill in the third column of Table B. The quarterly average is calculated as the simple average of the three months included in a particular quarter of the year.

Example: to calculate the quarterly average of the population for the first quarter of 1996:

  1. Calculate quarterly per capita real GDP (PCRGDP) by dividing real GDP by the population for each quarter. Enter this data in the fourth column of Table B on the following pages.

Example: to calculate the quarterly average of per capita real GDP for the first quarter of 1996 (note: to obtain a value in dollars per person, the result is multiplied by 10,000 because real GDP is measured in billions of dollars and population is measured in hundreds of thousands)

  1. Calculate the growth rate of per capita real GDP as the percentage change in the value of per capita real GDP from one quarter to the next and enter this data in the fifth column of Table B on the following pages.

Example: to calculate the percentage change in the value of per capita real GDP for the second quarter of 1996:

TABLE A

Year and Quarter / Nominal GDP
(NGDP)
(billions of $) / Real GDP
(RGDP)
(billions of chained 1996 $) / GDP Deflator
(DEF) / Growth Rate of GDP Deflator (%)
Inflation Rate
1996 Q1 / Not Applicable
1996 Q2
1996 Q3
1996 Q4
1997 Q1
1997 Q2
1997 Q3
1997 Q4
1998 Q1
1998 Q2
1998 Q3
1998 Q4
1999 Q1
1999 Q2
1999 Q3
1999 Q4
2000 Q1
2000 Q2
2000 Q3
2000 Q4

TABLE B

Year and Quarter / Real GDP
(RGDP)
(billions of chained 1996 $) / Population
(POP)
(hundreds of thousands of people) / Per Capita
Real GDP
(PCRGDP) / Growth Rate of Per Capita Real GDP (%)
1996 Q1 / Not Applicable
1996 Q2
1996 Q3
1996 Q4
1997 Q1
1997 Q2
1997 Q3
1997 Q4
1998 Q1
1998 Q2
1998 Q3
1998 Q4
1999 Q1
1999 Q2
1999 Q3
1999 Q4
2000 Q1
2000 Q2
2000 Q3
2000 Q4

Sources of Economic Data

Nominal GDP

Gross Domestic Product Billions of Dollars, Seasonally Adjusted Annual Rate Source: U.S. Department of Commerce, Bureau of Economic Analysis

Source:

Real GDP

Real Gross Domestic Product Billions of Chained 1996 Dollars, Seasonally Adjusted Annual Rate Source: U.S. Department of Commerce, Bureau of Economic Analysis

Source:

Population:

Total Population: All Ages Including Armed Forces Overseas Thousands Source: U.S. Department of Commerce, Census Bureau

Source:

2000 Poll Results:

Gallup Presidential Job Approval Rating:

Source:

Analysis of polling data including House and Senate control:

Source:

Assignment 2

Economic Indicators and National Election Predictions

Assignment Overview and Objectives:

In this assignment, you will learn how economic indicators can be used to predict national election results using an economic model. Using the data calculated in Assignment 1, you will generate election forecasts for the 2000 presidential election using an economic model developed by Ray Fair at Yale University. In addition, you will compare your predictions to those from public opinion polls and the Iowa Electronic Markets Presidential Vote-Share market.

Assignment:

1.Ray Fair, an economist at Yale University, has developed an economic model to predict the Democratic share of the two-party (Republican, Democrat) presidential vote. His model for the 2000 election is:

Dem. Vote Share = .423 + (.0070growth3) – (.0072inflation15) + (.0091highgrowth)

where

growth3 = growth rate of capita real GDP in the first three quarters of the election year

inflation15 = absolute value of the growth rate of the GDP deflator in the first 15 quarters of the administration that is in power in the year of the election

highgrowth = number of quarters in the first 15 quarters of the administration in which the growth rate of real per capita is greater than 3.2%

a.For the 2000 election, determine the numerical values of the variables: growth3, inflation15, and highgrowth and calculate the value of Vote Share using the model above.

b.Compare the value of the prediction from the Fair model to the actual 2000 election outcome. Calculate the absolute percent error of the two-party vote-share prediction as follows:

Note: Be sure to calculate the actual democratic vote share as a percentage of the two-partypresidential vote; i.e. (dem. presidential votes/(dem. presidential votes + rep. presidential votes)

c.Calculate the absolute percent error of the presidential two-party vote-share predictions from the IEM Presidential Vote-Share market using prices from

(1)October 1, 2000, and

(2)November 6, 2000 (the day before the election).

Note: Because the IEM Presidential Vote-Share market for the 2000 presidential election contained three contracts representing the share of the three-party presidential vote, you need to calculate the value of the IEM two-party vote share using the following formula:

d.Calculate the absolute percent error of the presidential vote-share predictions from one of the major national opinion polls on

(1)October 1, 2000, and

(2)November 6, 2000 (the day before the election)

Note: Depending on the poll, you may need to convert the vote-share predictions from the polls to a two-party vote share.

e.Which method (economic model, IEM markets, polls) provided the most accurate vote-share predictions (1) a month before the election (October 1, 2000), and (2) one day before the election (November 6, 2000)? Why do you think that was? Why did the other methods predict less accurately, in your view?

f.Based on your analysis and results, do you think that national economic conditions played a dominant role in the 2000 presidential election? Explain.

Evaluation Questions

Macroeconomic Conditions: Measurement and Political Implications

Essay questions:

  1. Briefly define and explain the followings:

-Inflation rate

-Unemployment rate

-National economic growth rate

-International trade deficit and surplus

  1. Assume that the economy has experienced both high inflation and unemployment rates, what is the terminology used to represent this condition? During what period has this occurred? How does the combination of high inflation and unemployment affect the reelection of the current president for a second term? How about the reelection of senators and members of congress?
  1. How is the inflation rate measured? What index is usually used to measure inflation? Why are high inflation rates are considered harmful?
  1. Who is officially considered “unemployed”? How is the unemployment measured? What is meant by the natural rate of unemployment?
  1. What is meant by the gross domestic production (GDP)? What is per capita GDP? Why is national economic growth measured by real per capita GDP?
  1. Does the external economic relation of the nation (trade deficit/surplus and capital inflow and outflow) have any effect on the value of dollar in the foreign exchange market and on the economy as a whole? Is a continuous trade deficit combined with capital outflow an indication of change in economic condition or the overall productivity of the nation?
  1. The Fair model is used as an example of economic models used for the prediction of an election. What are the general economic indicators used as variables in the Fair model? How does the model predict the election based on the economic conditions?
  1. IEM political market has had a good record in predicting the national elections. The traders in IEM political market use their judgement about the economic conditions as well as the public opinion polls to guide their trades. Evaluate this statement.
  1. What is the difference between consumer price index and the GDP deflator?

Multiple Choice Questions:

  1. The U.S. experienced highest inflation during the:
  1. 1960s
  2. 1970s
  3. 1980s
  4. 1990s
  1. During the 1990s,
  1. inflation increased and unemployment increased too
  2. inflation decreased and unemployment increased
  3. inflation increased and unemployment decreased
  4. inflation decreased and unemployment decreased too
  1. Consumer price index is a measure of
  1. costs and prices.
  2. cost of purchased goods by manufacturers.
  3. intermediate goods prices.
  4. change in the market value of a basket of goods and services that a typical urban person (household) consumes.
  1. Unemployed is officially defined as
  1. a person 16 years old or older who is not employed and has tried to find work during the last four weeks as recorded by the employment office
  2. a person who is retired or not working
  3. a person who has not been working at least three months
  4. a person who has not worked six months or more in the year.
  1. National debt is created by
  1. excessive consumer spending
  2. accumulated annual government budget deficits not offset by government budget surpluses
  3. excessive surplus and low deficit spending
  4. accumulated of debts in the business sector
  1. An increase in trade deficit combined with net capital outflow causes the value of dollar to
  1. increase in the foreign exchange market
  2. decrease in the foreign exchange market
  3. change only if the government sets a new rate
  4. none of the above
  1. The U.S. gross domestic product is
  1. the total market value of the all final goods and services produced by factors of production located in U.S. during a year
  2. the total market value of savings and investments
  3. total values of goods produced by U.S. citizens in U.S. and abroad
  4. total value of production in the 48 contiguous states in U.S.
  1. The Fair model as discussed in relation to IEM political markets can be used for prediction of
  1. the fair share of government expenditure as a percentage of GNP
  2. fairness of income distribution
  3. the vote share of Democratic presidential candidates in a national election
  4. fair share of business in political contributions for election.

Appendix A:

The Iowa Electronic Markets: Presidential Vote Share Market

Overview

This module assumes that you are familiar with the IEM Presidential Vote-Share market. The Iowa Electronic Markets (IEM for short) is a computerized market on which financial contracts can be traded (bought or sold). The contracts are briefly described in the following sections and in more depth in the IEM Trader’s Manual. Detailed descriptions of the Presidential Vote-Share market is available in the Prospectus, available at the IEM websites listed below:

Presidential Vote-Share Market Contracts

The IEM Presidential Election Market is a real-money futures market where contract payoffs are determined by the popular vote cast in the U.S. Presidential Election. The market is open to all traders world-wide. The payoffs in this market are based on the popular vote received by the Democratic, Reform, and Republican nominees in the U.S. Presidential election.

Description of Contracts

The financial contracts traded in this market are:

Code / Contract Name
DemVS / 1$ times 3-party vote share of Democratic Party nominee
ReformVS / 1$ times 3-party vote share of Reform Party nominee
RepVS / 1$ times 3-party vote share of Republican Party nominee

Once a party's official nominee is determined, the name of the associated contract will be changed for clarity. However, the contracts will always denote the official Democratic, Reform, and Republican party nominees. If a party's candidate subsequently drops out of the Presidential race, the related contract will denote the person designated as the official replacement by that party and the name of the contract will be changed accordingly.

Contract Liquidation

This is a vote-share market. To determine payoffs, the total popular vote received by the Democratic, Reform, and Republican nominees will be summed up and the percentage of that total that each of the three nominees received will be determined. Each contract will pay off $1.00 times that party's percentage of the three-party vote. For instance, contracts for a nominee that receives 32.4% of the three-party vote, will payoff 32.4 cents each. Votes received by any other presidential candidates will not be used to determine payoffs in this market.