Economics Chapter 15

Gross Domestic Product

•A statistic measure of the total income of everyone in the economy•The rate at which average prices are rising or falling (inflation/deflation), the percentage of the labor force that is out of work (unemployment) total spending in store (retail stores), or the imbalance of trade between the US and the rest of the world (trade deficit) - all = Macroeconomics


The study of the economy-wide phenomena. including inflation, unemployment and economic growth


The study of how households and firms make decisions and how they interact in markets

Gross Domestic Product GDP

Measures two things at once:• The total income of everyone in the economy•the total expenditure on the economy's output of goods and services•GDP can perform the trick of measuring both total income and total expenditure because theses two things are really the same**For and economy as a whole, income must equal expenditure*

Why is an economy's income the same as its expenditure?

•Because every transaction must have two parties:-A buyer-A seller•Every dollar of spending by some buyer is a dollar of income for some sellers

Circular Flow Diagram

•Another way to see the equality of income and expenditure •The diagram describes all the transactions between households and firms in a simple economy•Simplifies matters by assuming all goods and services are bought by households, and that households depend all of their income.•Markets-Goods and Services-Factors of production•Households-Spend income to buy goods and services•Firms-Pay wages, rent etc•Money continuously flows between between households and firms

Question:What two things does GDP measure? How can it measure two things at once?

Measures two things at once:• The total income of everyone in the economy•the total expenditure on the economy's output of goods and services•GDP can perform the trick of measuring both total income and total expenditure because theses two things are really the same


•Is the market value of all final foods and services produced within a country, in a given period of time•Market prices reflect the value of the goods•Of all items produced in the economy and sold LEGALLY in the markets- EXCLUDES most items-produced and sold illicitly -produced and consumed at home

GDP is the market value

•As the marker prices reflect the value of the goods•GDP adds together many different kinds of products into a sincle measure of the value of the economic activity, by using market prices•Because market prices measure the amount people are willing to pay for different goods, they reflect the value of those goodsEx. if the price of an apple is twice the price of an orange, then the apple contributes twice as much GDP as does an organge

..... OF ALL

Tries to be comprehensive•Includes all items produced in the economy and sold legally in markets•Also includes the market values of the housing services provided by the economy's stock of housing -For rental housing this value is easy to calculate- as the rent equals the the tenants expenditure and the landlords income•owners of households GDP is calculated by estimating rental value- based on the assumption the owner is renting to themselves- the imputed rent is included un both the homeowners expenditure and income so it adds to the GDP•Excludes most items -produced and sold illicitly/ illegally-produced and consumed at home and therefore never enter the marketplaceEX- Vegtiables you buy at a grocery store are part of GDP- while vegtables you grow in your garden are NOT•Can sometimes lead to Paradoxical resultsEx- Doug mowes Karens yard- then they get married and he still mows the yard... the value of moving the yard is now left out of GDP because dougs service is no longer sold in the marker-Marriage reduces GDP


•GDP only includes the valuee* of the final goods -This is done because the value of the intermediate good is already included in the price of the final good- adding the market value of the paper to the marker value of the final good would be bad and incorrectly count the paper twiceException•When the intermediate good is produced and rather than being used, it is added to a firm's inventory of goods for use or sale at a later date. •In this case the intermediate food is take to be "Final" for the moment and its value as inventory investment is inclused as part of GDP•Additions to inventory add to GDP and when the goods in inventory are later used or sold the reductions subtract from GDP

...Goods and Services...

•GDP includes both Tangible goods (food, clothing, cards) & intangible services (haircuts, housecleaning, dr visits) •EX- when you buy a CD- the purchase price is part of GDP•When you pay to hear a concert- you are buying a service- and the ticket price is also part of GDP


•Goods and services currently produced•it does not include transactions involving items produced in the past•When ford produces and sells a new car- the value of the car is included in GDP•When one person sells a used car to another, the value of the car is not included in GDP

....Within a Country...

•Measures the value of production within the geographic confines of a country.•when a canadian citizen works temp. in the US her production is part of US GDP•When an american owns a factory in Haiti the production of a factory is not part of the US GDP•Items are only included in the nations GDP id they are produced domestically- REGARDLESS of the nationally of the producer

....In a given period of time

•GDP measures the value of production that takes place within a specific interval of time. Usually the interval is a year or quarter (three months).•GDP measures the economy's flow of income, as well as its flow of expenditure during the interval•When the government reports the GDP for a quarter, it usually presents the GDP "at an annual rate"- meaning that the figure reported for the quarterly GDP is the amount of income and expenditure during the quarter multiplied by 4•This is done because the quarterly and annual GDP figures can be compared more easily•The gov. presents the GDP data after they have been modified by a statistical procedure called seasonal adjustment•the unadjusted data shows that the economy produces more goods and services during sometimes of the year than others EX- HOlidays, xmas•the GDP data reported on the news always has been seasonally adjusted


Is the market value of all final goods and services produced within a country in a given period of time.•This definition focuses on GDP as total expenditure in the economy •Every dollar spent by a buyer of a god or service becomes a dollar of income to the seller of that good or service.•In additional to this the government adds up total income in the economy two ways: and gives "almost" the same data. -The measures should be the same but the SOURCES are not always perfect, this difference is called Statistical Discrepancy•GDP is a sophisticated measure of the value of economic activity

Question:Which contributes more to GDP- The production of hamburger or the production of a pound of caviar? Why?


To understand how the economy is using its sacarce resources, economists study the composition of GDP among various types of spending. To do this-

GDP is denoted as (Y) and divided into four components:Consumption- CInvestment- IGovernment Purchases- GNet Exports- NXY = C + I + G + NX•This equation is an identity- an equation that must be true because of how the variables in the equation are defined. •Each dollar of expenditure of GDP is placed into one of the four components


•Spending by households on goods and services with the exception of purchases of new housing•Goods include- Durable goods such as:-automobiles-appliancesNondurable goods:-food-clothingServices include Intangible items such as -Haircuts-Medical care•Household spending on education is also included in consumption of services (some argue this should be an investment)


•Is the purchase of goods that will be used in the future to produce more goods and services. •It is the sum of purchases of capital equipment, inventories, and structures.•Investment in structures includes expenditures on new housing•By convention the purchase of a new house is the one form of household spending categorized as investment rather than consumption•The treatment of inventory accumulation is noteworthy•EX- Apple produces a computer and adds it to its inventory instead of selling it, Apple is assumed to have "purchased" the computer for itself.•The national income accountants treat the computer as part of apples investment spending.•If Apple later sells the computer our of inventory- Apples inventory investment will then be negative, offsetting the positive expenditure of the buyer.•Inventories are treated this way because one aim if GDP is to measure the value of the economy's production and goods added to inventory are part of that period's production. •Purchases of goods such as capital equipment, structures, and inventories used to produce other goods and services in the future

Government Purchases

•Spending on goods and services by local, state or federal governments•Includes- Salary of Government workers, as well as expenditures on public works•Included:-Salary of Army General, School teachers- this is part of Gov. purchasesNot included:- Gov. paying for Social Security for elderly, unemployment insurance benefit to a worker laid off----This is called a transfer paymentThese are called Transfer Payments because they are not made in the exchange for currently, produced good or service. •Transfer payments also alter household income, but they do not reflect the economy's productionBECAUSE- GDP is intended to measure income from and expenditure on the production of goods and services-•Transfer payments are NOT counted as part of government purchases

Net Exports

•Equals the foreign purchases of domestically produced goods (exports) minus the domestic purchases of foreign goods (imports)•A domestic firm's sale to a buyer in another country, such as Boeing's sale of an airplane to British airways increases net exports.•Net in Net Exports refers to the fact that imports are subtracted from exports. This subtraction is made because other components of GDP include imports of goods and services.Ex.- buy a new car for $40,000 for volv0- Increases consumption because car purchases are part of Consumer Spending. -Reduces Net Exports by $40,000 because the car is an import•Net Exports includes goods and services produced abroad (with a minus sign) because these goods and services are included in consumption, investment and government purchases (with a plus sign)•When a domestic household, firm, or government buys a good or service from abroad, the purchase reduces net exports, BUT because it also raises consumption, investment, or government purchases, it does not affect GDP.

Question:List the four components of expenditure. Which is the largest?


Question:If you want to see economy go up, you want to see ______ go up.


If Total Spending rises from one year to the next, at least one of two things must be true:

1. The economy is producing a larger output of goods or services2. Goods and Services are being sold at higher prices•When studying changes in the economy over time, economists want to separate these two effects. •They want to measure:Of the total quantity of goods and services the economy is producing that is not affected by changes in the prices of those goods and services.To do this- economists use a measure called Real GDP

Real GDP

•Answers a hypothetical question: what would be the value of the goods and services produced this year is we valued these goods and services at the prices that prevailed in some specific year in the past?•By evaluating current production using prices that are fixed in the past levels, real GDP shows how the economy's overall production of goods and services changes over time.

Total Spending

•Rises from one year to the next•Economy producing a larger output of goods and services•and/or the goods and services are being sold at higher prices

Nominal GDP

•The production of goods and services valued at current prices

Real GDP Cont.

•To obtain a measure of the amount produced that is not affected by changes in prices, we use Real GDP•The production of goods and services valued at constant prices•We calculate by designating one year as a "Base Year"•whe then use the prices of hot dogs and hamburgers in the vase year to compute the value of goods and services in all the years. •Not affected by changes in price•Just the output changes•Can tell if larger or smaller change- by changes in output levels•The prices in the base year provide the basis for comparing quantities in different years.

Nominal GDP VS Real GDP

•Nominal GDP uses current prices to place a value on the economy's production of goods and services VS•Real GDP uses constant base-year prices to place a value on the economy's production of goods and services. •Because Real GDP is not affected by changes in price, changes in Real GDP only reflect changes in the amounts being produced. •Thus, real GDP is a measure of the economy's production of goods and services

GDP Goal:

•is to gauge how well the overall economy is performing•Because real GDP measures the economy's production of goods and services, it reflects the economy's ability to satisfy people's needs and desires. •Thus, REAL GDP is a better gauge of economic well-being than is nominal GDP•When economists talk about the economy's GDP, they usually mean REAL GDP rather than nominal GDP•When they talk about growth in the economy, they measure that growth by the percentage change in REAL GDP, from one period to another

GDP Deflator

•reflects only the prices of goods and services•Calculated as:(Nominal GDP / Real GDP) X 100 •Because nominal and real GDP must be the same in the base year, the GDP deflator for the base year always equals 100•The GDP deflator for subsequent years measures the change in nominal GDP from the base year that cannot be attributed to a change in real GDP•Measures the current level of prices relative to the level of prices in the base year. •Reflects change in prices •Using the GDP deflator the inflation rate between TWO CONSECUTIVE years is commuted: Inflation rate in 2 years= (GDP deflator in year 2 - GDP deflator in year 1)---------------------------------------------------------------- X 100 GDP Deflator in year 1• GDP Deflator us one measure that economists use to monitor the average level or prices in the economy and this the rate of inflation.•Gets its name because it can be used to take the inflation out of nominal GDP - to "deflate" nominal GDP for the rise that is due to increases in prices


•Economists use this term to describe a situation in which the economy's overall price level is rising

Inflation Rate

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

Case Study

•Real GDP grows over time•Growth average 3% per year since 1965•Growth is not steady -GDP growth interrupted by recession


•2 consecutive quarters of falling GDP•Real GDP declines•Lower income•Rising unemployment•Falling Profits•Increased bankruptcies

Question:Define real GDP and nominal GDP. Which is a better measure of economic well-being? Why?


GDP Cont....

•Does help us lead good lives•GDP does not measure the health of our children, but nations with larger GDP can afford better healthcare for their children.•GDP does not measure the quality of educations, but nations with larger GDP can afford better educational systems•In short, GDP does not directly measure those things that make life worthwhile, but it does measure our ability to obtain many of the inputs into a worthwhile lifestyle.

Question:Why should policy makers care about GDP?