Macro CH19 Week1 Lecture Notes

1
Economics
6th edition, Global Edition
Chapter 19
GDP: Measuring Total
Production and Income
Copyright © 2017 Pearson Education, Ltd. All rights reserved.

2
Chapter Outline
19.1 Gross Domestic Product Measures Total Production
19.2 Does GDP Measure What We Want It to Measure?
19.3 Real GDP versus Nominal GDP
19.4 Other Measures of Total Production and Total Income

3
Microeconomics and macroeconomics

Microeconomics is the study of how households and firms make
choices, how they interact in markets, and how the government
attempts to influence their choices.
In contrast, macroeconomics is the study of the economy as a
whole, including topics such as inflation, unemployment, and
economic growth.
• When we want to study the overall economy-level actions of
people and governments, the models and tools of
macroeconomics become very useful.

4
Some important macroeconomic terms

Business cycle: Alternating periods of economic expansion and
economic recession.
Expansion: The period of a business cycle during which the total
production and total employment are increasing (together)
Recession: The period of a business cycle during which total
production and total employment are decreasing (together)
Economic growth: The ability of an economy to produce
increasing quantities of goods and services
Inflation rate: The percentage increase in the price level from one
year to the next

5
Goal of this chapter

Over the coming chapters, we will explore many aspects of the
economy, including how all of the elements on the previous slide
relate to one another.
For this chapter, we have a less lofty goal: to figure out how to
measure the total output of an economy.
• Being able to measure total output is incredibly important, since
much of macroeconomics depends on our ability to measure
and predict aggregate economic activity.

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19.1 Gross Domestic Product Measures

Total Production
Explain how total production is measured
The most common measure used by economists of overall

economic activity in an economy is Gross Domestic Product, or
GDP.
Gross Domestic Product (GDP): the 1.market value of 2.all final
goods and services 3.produced in a country during 4.a period of
time, typically one year.
We will examine each of the parts of this definition in turn.

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“Market values”
Gross Domestic Product: the market value of all final goods and
services produced in a country during a period of time, typically
one year.
We cannot add together the number of cars, melons, haircuts, and
all other goods and services without agreeing on a common way
to measure them.
The best practical way is to value each good and service in
monetary terms; and the best measure of this that we have is the
price that each good or service is sold for.

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“Final goods and services”

one year. (intermediate goods and services didn’t count)
A final good or service is a good or service purchased by a final
user. These are what are used to calculate GDP.
• Why? If we counted intermediate goods and services as well,
ones that were inputs into another good or service, such as a
tire on a truck, then we would end up double-counting.
Example: if we counted the value of the ice cream bought by a
store, and also counted the value of that ice cream when it was
sold to a consumer, we would be double-counting the wholesale
value of the ice cream.

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“During a period of time”

one year.
To measure total output in a given year, we measure the goods
and services produced only in that given year.
• Again, this avoids double-counting: if you buy a DVD in 2011,
that DVD counts in 2011’s GDP. If you resell it in 2012, it will not
count again in 2012.
• So GDP counts only new goods and services. Used items were
previously produced and counted, so don’t need to be counted
again.

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Problem 1
Production and Price Statistics for 2013
(1) (2) (3)
Product Quantity Price per Unit
Eye examinations 100 $50.00
Pizzas 80 10.00
Textbooks 20 100.00
Paper 2,000 0.10
(1) (2) (3)

Product Quantity Price per Unit Value
Eye examinations 100 $50 $5,000
Pizzas 80 10 800
Textbooks 20 100 2,000
Add the value for each of the three final goods and services to find GDP.
GDP = Value of eye examinations produced + Value of pizzas produced +

Value of textbooks produced = $5,000 + $800 + $2,000 = $7,800.

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Production and income

There are two main conceptual ways to measure the total
economic activity in an economy: total production or total income.
When we measure one, we are also measuring the other.
• Why? Everything that is produced and sold constitutes income
for someone; so we have the choice of measuring the value of
products produced and sold, or the value of incomes, and each
is a valid way of measuring economic activity.

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Figure 19.1 The circular flow and the measurement of GDP

(1 of 4)
In a very simple model of

the economy, we could start
with households and firms.
To measure overall
economic activity, we could
measure the amount of
money that households
spend on goods and
services.
Or we could measure
income to households.

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(2 of 4)
Let’s add in some more layers.

We’ll start with government.
How does the government
affect economic activity?
• It takes in taxes from
households and firms.
• It uses those taxes to buy
goods and services, and to
make transfer payments—
payments to households for
which the government does
not receive a good or
service in return.
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(3 of 4)
Some economic
activity takes place
between households,
firms, and the rest of
the world.
• Households buy
goods and services
from firms in other
countries; these are
known as imports.
• Firms sell goods
and services to
households in other
countries; these are
known as exports.
15

(4 of 4)
Finally, there are firms
that deal specifically in
flows of money; we
label these firms the
financial system.
• Households elect not
to spend some of
their income, and
instead save it with
financial system firms
like banks.
• These financial
system firms lend
money to other firms
and the government.
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Follow the spending to measure GDP

To measure GDP, the Bureau of Economic Analysis (BEA) in the
Department of Commerce measures four major categories of
expenditures: (Expenditure Approach)
• Personal Consumption Expenditures, or Consumption (C)
• Gross Private Domestic Investment, or Investment (I)
• Government Consumption and Gross Investment, or
Government Purchases (G)
• Net Exports of Goods and Services, or Net Exports (NX)
GDP can be expressed as the sum of these:
Y = C + I + G + NX
We will examine each component of GDP in turn.

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Consumption
Y = C + I + G + NX
Consumption is spending by households in goods and services,
not including spending on new houses (which are counted instead
in investment).
In BEA statistics, consumption is further divided into expenditure
on
• Services, such as medical care, education, and haircuts
• Non-durable goods, such as food and clothing, and
• Durable goods, such as automobiles and furniture.

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Investment
Y = C + I + G + NX
Investment is spending by firms on new factories, office buildings,
and additions to inventories, plus spending by households and
firms on new houses.
The BEA measures the following categories of investment:
• Business fixed investment, such as new factories, office
buildings, machinery, and research and development.
• Residential investment, i.e. new single-family and multi-unit
houses
• Changes in business inventories, i.e. goods that have been
produced but not yet sold.
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Government purchases
Y = C + I + G + NX
Government purchases are spending by federal, state, and local
governments on goods and services, such as teachers’ salaries,
highways, and aircraft carriers.
This does not include transfer payments, since those do not result
in immediate production of new goods and services.
We used the transfer payment to buy goods and services, if we
count the transfer payment into GDP. It will be double counting as
buying goods and services will count in consumption.

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Net exports
Y = C + I + G + NX
Net exports are the value of exports minus the value of imports.
(X-M)
This difference might be positive or negative; in recent years, this
has been negative in the United States.
Since we want to count domestic production (production in the
United States), we add up the value of the goods and services
sold to foreigners, and subtract off the value of the goods and
services sold to Americans by foreigners.

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Figure 19.2 Components of GDP in 2014
Consumption is the largest component of GDP; within that,

services are the largest component—almost half of GDP.
American net exports are negative, since the value of our imports
exceeds the value of our exports.
22
Components of China GDP in 2016
44.18%
39.21%
percentage of GDP
14.41%
2.20%
PRIVATE CONSUMPTION GOVERNMENT GROSS CAPITAL NET EXPORTS OF GOODS

EXPENDITURE CONSUMPTION FORMATION AND SERVICES
EXPENDITURE
Gross capital formation is investment

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Components of HK GDP in 2016
66.16%
percentage of GDP
21.52%
9.96%
0.23% 2.13%
PRIVATE GOVERNMENT GROSS DOMESTIC CHANGES IN NET EXPORTS OF

CONSUMPTION CONSUMPTION FIXED CAPITAL INVENTORIES GOODS AND
EXPENDITURE EXPENDITURE FORMATION SERVICES
Gross Domestic fixed capital formation+ change in inventories = Investment

24
Components of HK GDP in 2016
187.37% 185.24%
percentage of GDP
66.16%
21.52%
9.96% 0.23% 2.13%
PRIVATE GOVERNMENT GROSS CHANGES IN EXPORTS OF IMPORTS OF NET EXPORTS

CONSUMPTION CONSUMPTION DOMESTIC INVENTORIES GOODS AND GOODS AND OF GOODS AND
EXPENDITURE EXPENDITURE FIXED CAPITAL SERVICES SERVICES SERVICES
FORMATION

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Table 19.1 Calculating value added
An alternative method to measure GDP is to measure the value

added: the market value a firm adds to a product.
The final selling price of a product must equal the sum of the
values added to the product at each stage of production.
The table illustrates this method for a shirt sold on L.L.Bean’s web
site.
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Application 2
Suppose that a devastating earthquake hits the capital city of a
country. The earthquake the results in the destruction of most of
its buildings. However, the authorities successfully manage to
save all the inhabitants of the capital, so that there are no
casualties reported. It is noted immediately afterwards that the
population decide to rebuild the city, in the exact same way as it
was before. The capital starts working hard to achieve the
objective. By the end of the year, the city is rebuilt. Would the
events that occurred affect the GDP of the country?

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19.2 Does GDP Measure What We

Want It to Measure
Discuss whether GDP is a good measure of well-being
GDP can be a useful tool to measure total output in an economy.

Many people go further than this, interpreting GDP as a measure
of the well-being of citizens.
However GDP has shortcomings, as both a
• Measure of total production, and a
• Measure of well-being.

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Shortcomings of GDP as a measure of

total production
Two important types of production are omitted忽略 from the BEA’s
measurement of GDP:
Household production such as childcare, cleaning, and cooking is
not typically paid for with money.
• But such contributions are real—if they were performed by a non-
household-member, they would be paid for and counted in GDP.
Underground economy: Buying and selling of goods and services
that is concealed 隱瞞 from the government to avoid taxes or
regulations, or because the goods and services are illegal
• This may be 10% or more of the economy in America, and
substantially more in low-income households.

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How important are these shortcomings?

If we are comparing GDP from year to year, the size of household
production and the underground economy is probably about the
same from year to year, so GDP growth is a reasonable measure
of the growth in total production.
However over long periods of time, these shortcomings might be
more serious.
Example: As women have entered the workforce in larger
numbers, some household production has been replaced by paid
childcare and restaurant meals. So increases in GDP may
exaggerate the increase in actual total production.

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Shortcomings of GDP as a measure of

well-being
GDP per capita (i.e. GDP divided by population) is often used to
represent differences in standards of living from country to
country. However, even if it accurately measured total production,
it would not reflect:
• The value of leisure
• Pollution and other negative effects of production
• Crime and other social problems
• The distribution of income
In fact, improvements in many of these will result in lower GDP
per capita.
Example: Lower crime would allow lower spending on police,
prisons, and private security. This would decrease GDP, but surely
result in improvements in economic well-being.
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19.3 Real GDP versus Nominal GDP

Discuss the difference between real GDP and nominal GDP
Suppose GDP increases; is the increase in GDP due to production

increasing, or due to prices increasing?
• To separate these effects, the BEA calculates both Nominal
GDP—the value of final goods and services evaluated at
current-year prices—and Real GDP—the value of final goods
and services evaluated at base-year prices.
The choice of a base-year is arbitrary; we might use any year’s
prices to compare real GDP. The current standard is 2009.
• Unfortunately, the relative prices also change from year to year,
distorting real GDP calculations. Since 1996, the BEA has
overcome this problem by using chain-weighted prices, using
previous-year prices to adjust current-year production.
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Calculating real GDP: an example
The table shows output and prices in 2009 and 2017.

• Calculating the total value of output in 2009 gives:
$3,200 + $990 + $1,350 = $5,540.
To calculate real GDP in 2017, we use the prices from

2009.(Based year)
• This gives real 2017 GDP in 2009 dollars of $6,680.
(100*40+80*11+20*90)
• Compare this to nominal GDP in 2017 of $7,800.
(100*50+80*10+20*100)

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Figure 19.3 Nominal GDP and real GDP. 1990-2014
The current base year

for calculating prices
is 2009, so real and
nominal GDP are
equal in 2009.
Growth figures
reported in the media
are the growth in real
GDP.
Since prices have
generally increased
since 2009, real GDP
is less than nominal
GDP, and the opposite
is true before 2009.
34
The GDP deflator

Economists and policy-makers are interested in the price level: a
measure of the average prices of goods and services in the economy.
• Why? Stable prices are desirable because they allow households
and firms to plan for the future appropriately.
In order to know whether we are achieving price stability, we need to
measure the price level.
• One way to do this is using the GDP deflator: a measure of the
price level, calculated by dividing nominal GDP by real GDP and
multiplying by 100:
Nominal GDP
GDP deflator = × 100
Real GDP
Since nominal and real GDP will be the same in the base year, the
GDP deflator will be 100 in the base year.
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Calculating GDP deflator: an example
The first table gives nominal and real GDP for 2013 and 2014.
We can use this to calculate the GDP deflator in each year.
• The GDP deflator increased from 108.3 to 106.7:
108.3 − 106.7
× 100 = 1.5%
106.7
So we can say the price level rose by 1.5% over this period.
36
19.4 Other Measures of Total Production

and Total Income
Describe other measures of total production and total income
Each quarter, the BEA publishes the National Income and Product
Accounts tables. These include GDP computations, but also:
• Gross National Product (GNP): Production performed by
citizens of a nation, including overseas production
• National Income: GDP minus the consumption of fixed capital;
i.e. GDP minus depreciation
• Personal Income: Income received by households; includes
transfer payments, but excluded firms’ retained earnings
• Disposable Personal Income: Personal income minus personal
tax payments; this measures the amount that households are
able to spend or save

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Figure 19.4 Measures of total production and total income,

2014
The table and graph show the various measures of the national
income accounts for the United States in 2012.
• National income must be smaller than GDP, since it is just GDP
minus depreciation.
• Similarly, disposable personal income must be less than personal
income, since it is just personal income minus taxes.
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Figure 19.5 The division of income, 2014
All production must be rewarded with income; so in theory, we

could count either in order to calculate GDP.
• In practice, data limitations make us unlikely to come up with
the same number; there will always be some statistical
discrepancy.
The figure illustrates the division of income as measured by the
BEA in 2012.

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1

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Microeconomics and macroeconomics

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Some important macroeconomic terms

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Goal of this chapter

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

19.1 Gross Domestic Product Measures

The most common measure used by economists of overall

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

“Final goods and services”

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

“During a period of time”

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

(1) (2) (3)

GDP = Value of eye examinations produced + Value of pizzas produced +

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Production and income

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Figure 19.1 The circular flow and the measurement of GDP

In a very simple model of

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Figure 19.1 The circular flow and the measurement of GDP

Let’s add in some more layers.

Figure 19.1 The circular flow and the measurement of GDP

Figure 19.1 The circular flow and the measurement of GDP

Follow the spending to measure GDP

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Figure 19.2 Components of GDP in 2014

Consumption is the largest component of GDP; within that,

Components of China GDP in 2016

PRIVATE CONSUMPTION GOVERNMENT GROSS CAPITAL NET EXPORTS OF GOODS

Gross capital formation is investment

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Components of HK GDP in 2016

PRIVATE GOVERNMENT GROSS DOMESTIC CHANGES IN NET EXPORTS OF

Gross Domestic fixed capital formation+ change in inventories = Investment

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Components of HK GDP in 2016

PRIVATE GOVERNMENT GROSS CHANGES IN EXPORTS OF IMPORTS OF NET EXPORTS

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Table 19.1 Calculating value added

An alternative method to measure GDP is to measure the value

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

19.2 Does GDP Measure What We

GDP can be a useful tool to measure total output in an economy.

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Shortcomings of GDP as a measure of

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

How important are these shortcomings?

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Shortcomings of GDP as a measure of

19.3 Real GDP versus Nominal GDP

Suppose GDP increases; is the increase in GDP due to production

Calculating real GDP: an example

The table shows output and prices in 2009 and 2017.

To calculate real GDP in 2017, we use the prices from

Copyright © 2017 Pearson Education, Ltd. All rights reserved.

Figure 19.3 Nominal GDP and real GDP. 1990-2014

The current base year