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MEASURING ECONOMIC ACTIVITY

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GROSS DOMESTIC PRODUCT

GDP is the market value of all final goods and services produced within a country in a given period of time.

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GROSS DOMESTIC PRODUCT

GDP is the Market Value . . .

Output is valued at market prices.

. . Of All Final . . .
intermediate goods (the value is counted only once).

It records only the value of final goods, not

. . Goods and Services . . .

clothing, cars) and intangible services (haircuts, housecleaning, doctor visits).

It includes both tangible goods (food,

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GROSS DOMESTIC PRODUCT

.

. . Produced . . .
produced, not transactions involving goods produced in the past.

It includes goods and services currently

. . . Within a Country . . .
geographic confines of a country.

It measures the value of production within the

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GROSS DOMESTIC PRODUCT

.

. . In a Given Period of Time.

takes place within a specific interval of time, usually a year or a quarter (three months)

It measures the value of production that

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GROSS DOMESTIC PRODUCT

GDP includes all items produced in the economy and sold legally in markets. GDP excludes most items that are:
produced and consumed at home and

that never enter the marketplace, drugs.

produced and sold illicitly, such as illegal

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How to measure GDP?

GDP

can be measured as .

1. a sum of spending (or expenditure) on final products, or 2. a sum of income or earnings Both approach yield exactly the same measure of GDP, because
.every transaction has a buyer and a seller. .every dollar of spending by some buyer is a

dollar of income for some seller

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Circular Flow of Economic Activity

Reven ue Go ods and services s o l d MARKE TS F O GOODS AND SERVICES R Firms sell Households buy Spendi ng Goods and servic es bou ght

FIR MS Produce and sell goods and services Hire and use factors of production

HOUSEHOLD S Buy and consume goods and services Own and sell factors of production

Factors of producti on Wages, rent, and profit

MARKE TS F FACTORS OF O PRODUCTION R Households sell Firms buy

Labor, land, and capital Inco me = Flow of inputs and outputs = Flow of

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The Problem of Double Counting

How

to avoid double counting?

We have to include only final goods that are

produced and sold for consumption or investment, and exclude the intermediate goods that are used up in making the final goods.
We have to calculate value added at each stage

of production.
The value added can be defined as the difference

between a firms sales and its purchases of materials and services from other firms.

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GDP Sums up Value Added at Each Production Stage

Stage of Production Wheat Flour Baked dough Final product: bread Total
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Sales receipts (1) 23 53 110 190 376

Less: Cost of intermediate products (2) 0 23 53 110 186

Value added (wages, profits, etc.) (3) = (1) (2) 23 30 57 80 190

Note: final sales of bread = total earnings = total value added = 190

Expenditure Approach
1 Personal consumption expenditures Durable goods Nondurable goods Services Gross private domestic investment Fixed investment (both residential and nonresidential) Change in private inventories Government consumption expenditure and gross investment (both state and local government) Net export of goods and services

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Income Approach
1 2 3 4 5 6 7 Wages, salaries, and other labor incomes Interest Rental income of person Indirect business taxes Depreciation Income of unincorporated enterprises Corporate profits before taxes Corporate profit taxes Dividend Undistributed profit

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DETAIL OF THE COMPONENTS OF GDP

GDP

(Y) is the sum of the following:

Consumption (C) Investment (I) Government Purchases (G) Net Exports (NX)

Y = C + I + G + NX

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DETAIL OF THE COMPONENTS OF GDP

Consumption

(C)

The spending by households on goods and

services, with the exception of purchases of new housing.

Investment

(I)

The spending on capital equipment,

inventories, and structures, including new housing.

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DETAIL OF THE COMPONENTS OF GDP

Government

Purchases (G)

The spending on goods and services by

local, state, and federal governments.

Does not include transfer payments because

they are not made in exchange for currently produced goods or services.
Net

Exports (NX)

Exports minus imports.

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REAL VERSUS NOMINAL GDP

Nominal GDP values the production of goods and services at current prices. Real GDP values the production of goods and services at constant prices.
An accurate view of the economy requires adjusting nominal to real GDP by using the GDP deflator.

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REAL VERSUS NOMINAL GDP

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The GDP Deflator

The GDP deflator is a measure of the price level calculated as:

It

tells us the rise in nominal GDP that is attributable to a rise in prices rather than a rise in the quantities produced.

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The GDP Deflator

Year 2001 2002 2003 Calculating the GDP Deflator ($200/$200) x 100 = 100 ($600/$350) x 100 = 171 ($1,200/$500) x 100 = 240

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Expenditure of Gross Domestic Product 2009 (Billion Rupiahs)

TYPE OF EXPENDITURE 1 2 3 4 5 6 7 8 9 10 11 12 Private consumption expenditure General government consumption expenditure Gross domestic fixed capital formation a. Change in inventory b. Statistical discrepancy* Export of goods and services Less import of goods and services GROSS DOM ESTIC PRODUCT (GDP) Net Factor income from abroad GROSS NATIONAL PRODUK (GNP) Less net indirect taxes (indirect taxes minus subsidy) Less depreciation NATIONAL INCOM E (NI) at current at constant market 2000 market prices price 3,290,843.3 537,588.8 1,744,381.2 -7,264.2 -118,994.7 1,354,409.4 1,197,092.7 5,603,871.2 -196,219.5 5,407,651.6 214,833.2 280,193.6 4,912,624.9 1,249,011.2 195,907.7 510,118.1 -474.3 -1,124.2 932,123.6 708,586.6 2,176,975.5 -109,819.3 2,067,156.2 64,782.0 108,848.8 1,893,525.5

* Defferent betw een GDP by industrial origin and expenditure of GDP

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Gross Domestic Product by Industrial Origin 2009 (Billion Rupiahs)

INDUSTRIAL ORIGIN 1 2 3 4 5 6 7 8 9 Agriculture, Livestock, Forestry and Fishery Mining and Quarrying Manufacturing industry Electricity, Gas and Water Supply Construction Trade, Hotel and Restaurant Transport and Communication Financial, Ownership and Business Services Services GROSS DOMESTIC PRODUCT at current at constant market 2000 market prices price 858,252.0 296,369.3 591,531.7 179,974.9 1,480,905.4 569,550.8 46,823.1 17,059.8 554,982.2 140,184.2 750,605.0 367,958.8 352,407.2 191,674.0 404,116.4 208,832.2 573,818.7 205,371.5 5,613,441.7 2,176,975.5

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GDP Vs GNP

GDP is the total market value of all final goods and services produced within a country in a given period of time. GNP is the total market value of final goods and services produced during a given period by the factors owned by a nation. GNP = GDP + (IR IP)

IR = factor income received from abroad IP = factor income paid to abroad IR IP = net factor income received from abroad
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From GDP to National Income (NI) to Disposable Income (di)

GDP

= C + I + G + NX

Less Depreciation Less Indirect Taxes

Equal

to National Income (NI)

Minus Direct Taxes Minus Net Business Saving Plus Transfer payment

Equal
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to Disposable Income (DI)

GDP AND ECONOMIC WELLBEING

GDP GDP

is the best single measure of the economic well-being of a society. per person tells us the income and expenditure of the average person in the economy.

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GDP AND ECONOMIC WELLBEING

Higher

GDP per person indicates a higher standard of living. GDP is not a perfect measure of the happiness or quality of life.

However,

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GDP AND ECONOMIC WELL-BEING

Some

things that contribute to wellbeing are not included in GDP.

The value of leisure. The value of a clean environment. The value of almost all activity that takes

place outside of markets, such as the value of the time parents spend with their children and the value of volunteer work.

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GDP, Life Expectancy, and Literacy

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PRICE INDEXES AND INFLATION

Price

index (P) is a measure of the average level of price. refers to a situation in which the economys overall price level is rising. inflation rate () is the percentage change in the price level from the previous period.

Inflation The

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THE CONSUMER PRICE INDEX

The

consumer price index (CPI) is a measure of the overall cost of the goods and services bought by urban consumer. fixed weight is used to calculate CPI. is used to monitor changes in the cost of living over time.
When the CPI rises, the typical family has to

The CPI

spend more dollars to maintain the same standard of living.

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Calculating the CPI and the Inflation Rate

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GDP PRICE INDEX

The

GDP price index (or GDP deflator) is the price of all goods and services produced domestically. is a chain-weighted index that take into account the changing shares of different goods.

It

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THE PRODUCER PRICE INDEX

The

produces price index (PPI) measures the cost of a basket of goods and services bought by firms rather than consumers. measure the level of prices commodity at the wholesale or producer stage. fixed weight used to calculate PPI are the net sales of each commodity.

It

The

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Problems in Measuring the Cost of Living

The

CPI is an accurate measure of the selected goods that make up the typical bundle, but it is not a perfect measure of the cost of living.

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Problems in Measuring the Cost of Living

1. Substitution bias
The basket does not change to reflect

consumer reaction to changes in relative prices.

Consumers substitute toward goods that have

become relatively less expensive.

The index overstates the increase in cost of

living by not considering consumer substitution.

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Problems in Measuring the Cost of Living

2. Introduction of new goods
The basket does not reflect the change in

purchasing power brought on by the introduction of new products.

New products result in greater variety, which in

turn makes each dollar more valuable.

Consumers need fewer dollars to maintain any

given standard of living.

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Problems in Measuring the Cost of Living

3. Unmeasured quality changes
If the quality of a good rises from one year to

the next, the value of a dollar rises, even if the price of the good stays the same.
If the quality of a good falls from one year to

the next, the value of a dollar falls, even if the price of the good stays the same. quality, but such differences are hard to measure.

The BPS tries to adjust the price for constant

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Problems in Measuring the Cost of Living

The substitution bias, introduction of new goods, and unmeasured quality changes cause the CPI to overstate the true cost of living.
The issue is important because many

government programs use the CPI to adjust for changes in the overall level of prices. percentage point per year.

The CPI overstates inflation by about 1

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CORRECTING ECONOMIC VARIABLES FOR THE EFFECTS OF INFLATION

Price

indexes are used to correct for the effects of inflation when comparing dollar figures from different times. For example:
S a l a 2 r0 y = S 0 1 a l a1 9r 3y 1 P P r i c e r i c e l l ei nv e 2 0 0 1 l l ei nv e 1 9 3 1

= $ 8 , 00 0 0

1 7 7 1 52 .

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= $ 9 3, 5 1 7 9

Indexation
When

some dollar amount is automatically corrected for inflation by law or contract, the amount is said to be indexed for inflation.

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Real and Nominal Interest Rates

Interest

represents a payment in the future for a transfer of money in the past. nominal interest rate is the interest rate usually reported and not corrected for inflation.
It is the interest rate that a bank pays.

The

The

real interest rate is the nominal interest rate that is corrected for the effects of inflation.

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Real and Nominal Interest Rates

You

borrowed $1,000 for one year. interest rate was 15%. the year inflation was 10%.
= 15% - 10% = 5%

Nominal During

Real interest rate = Nominal interest rate Inflation

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Assignment-2
Questions for discussion, problems and application at the end of the chapter.

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