Economic Topic 7

Topic 7
Introduction to
Macroeconomics:
Measuring the
Macro economy
Mankiw: Macroeconomics, 9th edition, Chapter 2 13 November 2023

What is Macroeconomics?
❑ Macroeconomics is the study of the economy as a

whole, including growth in incomes, changes in
prices, and the rate of unemployment.
➢ Macroeconomists attempt both to explain economic

events and to devise policies to improve economic
performance.
2
Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

Measuring the Value of Economic Activity:
Gross Domestic Product
❑ Gross domestic product (GDP) is the market value of all final
goods and services produced within an economy in a given
period of time.
➢ GDP is often considered the best measure of how well an
economy is performing.
❑ Two ways to view this statistic:

➢ as the total income of everyone in the economy;
➢ as the total expenditure on the economy’s output of goods
and services.
❑ To understand the meaning of GDP more fully, we turn to

national income accounting, the system used to measure GDP
and many related statistics.
3

Measuring the Value of Economic Activity:
Gross Domestic Product
Income, Expenditure, and the Circular Flow
There are 2 ways
of viewing GDP Total income of everyone in the economy
GDP measures
GDP is the value
the flow of
of total output
dollars in the (production) in
economy. the economy
Total expenditure on the economy’s output of goods and services

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e
Rules for Computing GDP
❑ Intermediate Goods and Value Added
➢ Many goods are produced in stages: raw materials

are processed into intermediate goods by one firm
and then sold to another firm for final processing.
➢ For example, suppose a cattle rancher sells one-

quarter pound of meat to McDonald’s for $1, and
then McDonald’s sells you a hamburger for $3.
❖Should GDP include both the meat and the

hamburger (a total of $4) or just the hamburger
($3)? 5

➢ Intermediate Goods, Value Added and GDP

➢ GDP includes only the value of final goods. Thus, the
hamburger is included in GDP but the meat is not:
GDP increases by $3, not by $4.
❖Why?
➢ The value of the final goods already includes the
value of the intermediate goods, so including
intermediate and final goods in GDP would be
double-counting.
✓ GDP is the total value of final goods and services
6
produced.

❖ One way to compute the value of all final goods and services is
to sum the value added at each stage of production.
➢ The value added of a firm equals the value of the firm’s output
less the value of the intermediate goods that the firm purchases.
▪ In the case of the hamburger, the value added of the rancher is
$1 (assuming that the rancher bought no intermediate goods),
and the value added of McDonald’s is $3 - $1, or $2. Total value
added is $1 + $2, which equals $3.
➢ For the economy as a whole, the sum of all value added must
equal the value of all final goods and services.
✓ Hence, GDP is also the total value added of all firms in the
economy. 7

❖Exercise:
▪ A farmer grows a bushel of wheat and sells it to a miller
for $1.
▪ The miller turns the wheat into flour and then sells the
flour to a baker for $3.
▪ The baker uses the flour to make bread and sells the
bread to an engineer for $6.
▪ The engineer eats the bread.
Compute & compare
value added at each stage of production
and GDP 8

❑ Used Goods
➢ Used goods are not included in the calculation of
GDP.
❑ The Treatment of Inventories

➢ The treatment of inventories depends on if the goods
are stored or if they spoil.
✓ If the goods are stored, their value is included in GDP.
✓ If they spoil, GDP remains unchanged.
✓ When the goods are finally sold out of inventory, they
are considered used goods (and are not counted).

❖Question?
➢ Suppose a firm
o produces $10 million worth of final goods
o but only sells $9 million worth.
❖Does this violate the expenditure = output identity?
10

❖Why output = expenditure
▪ Unsold output goes into inventory,

and is counted as “inventory investment”…
…whether or not the inventory buildup was intentional.
➢ In effect, we are assuming that firms purchase their

unsold output.
11

❑ Housing Services and Other Imputations
➢ Some goods are not sold in the marketplace and

therefore don’t have market prices.
➢ If GDP is to include the value of these goods and
services, we must use an estimate of their value.
✓ Such an estimate is called an imputed value.
12

➢ In many cases, an imputation is called for in principle but, to
keep things simple, is not made in practice.
❖ Some of the output of the economy is produced and consumed
at home and never enters the marketplace. For example, the
value added when a person prepares a meal at home is left out
of GDP.
➢ No imputation is made for the value of goods and services sold
in the underground economy.
✓ Because the imputations necessary for computing GDP are only
approximate, and because the value of many goods and
services is left out altogether, GDP is an imperfect measure of
economic activity.
✓ Yet as long as the magnitude of these imperfections remains
fairly constant over time, GDP is useful for comparing economic
13
activity from year to year.
GDP:
An important and versatile concept
❑We have now seen that GDP measures
✓ total income
✓ total output
✓ total expenditure
✓ the sum of value-added at all stages
in the production of final goods
14

Real GDP Versus Nominal GDP
❑ GDP is the value of all final goods and services

produced.
➢ Nominal GDP measures these values using current

prices.
➢ Real GDP measure these values using the prices of a

base year.
15

Practice problem 1
2014 2015 2016 2017

P Q P Q P Q P Q
good A $30 900 $31 1,000 $36 1,050 $45 890
good B $100 192 $102 200 $100 205 $140 190
 Compute nominal GDP in each year.

 Compute real GDP in each year using 2014 as
the base year.
Answers to practice problem 1
nominal GDP multiply Ps & Qs from same year

2014: $46,200 = $30  900 + $100  192
2015: $51,400
2016: $58,300
2017: $ 66,650
real GDP multiply each year’s Qs by 2014 Ps
2014: $46,200
2015: $50,000
2016: $52,000 = $30  1050 + $100  205
2017: $45,700
Real GDP controls for inflation
❑ Changes in nominal GDP can be due to:

➢ changes in prices.
➢ changes in quantities of output produced.
❑ Changes in real GDP can only be due to

changes in quantities,
➢ because real GDP is constructed using
constant base-year prices.
18

GDP Deflator
❑ The inflation rate is the percentage increase in the

overall level of prices.
❑ One measure of the price level is
the GDP deflator, also called the implicit price
deflator for GDP, defined as
Nominal GDP
GDP deflator = 100 
Real GDP
19

Practice problem 2
GDP Inflation
Nom. GDP Real GDP
deflator rate
2014 $46,200 $46,200 n.a.
2015 51,400 50,000
2016 58,300 52,000
2017 66,650 45,700

❑ Use your previous answers to compute
the GDP deflator in each year.
❑ Use GDP deflator to compute the inflation rate from 2014 to
202015, from 2015 to 2016 and from 2016 to 2017.

Answers to practice problem 2
Nominal GDP Inflation

Real GDP
GDP deflator rate
2014 $46,200 $46,200 100.0 n.a.
2015 51,400 50,000 102.8 2.8%
2016 58,300 52,000 112.1 9.1%
2017 66,650 45,700 145.8 30.06

Nominal GDP, Real GDP and GDP Deflator
❑ Nominal GDP measures the current dollar value of

the output of the economy.
❑ Real GDP measures output valued at constant
prices.
❑ The GDP deflator measures the price of output
relative to its price in the base year.
➢The GDP deflator reflects what’s happening to
the overall level of prices in the economy.
22

Other Measures of Income
❑ Gross Domestic Product (GDP): Total income

earned by domestically-located factors of production,
regardless of nationality.
❑ Gross National Product (GNP): Total income earned

by the nation’s factors of production, regardless of
where located.
➢ GNP – GDP = factor payments from abroad –

factor payments to abroad
23

✓ GDP measures the total income produced

domestically.
✓ GNP measures the total income earned by nationals

(residents of a nation).
▪ For example, if a Japanese resident owns an

apartment building in New York, the rental income he
earns is part of U.S. GDP, because it is earned in the
United States. But because this rental income is a
factor payment to abroad, it is not part of U.S. GNP.
24

❑ Net National Product (NNP): Net result of the economic
activity
➢ NNP = GNP-Depreciation
❑ Net National Income (NNI): How much every one in the

economy earned.
➢ NNI = NNP-Indirect Business Taxes (net)
❑ Net National Income (NNI) = C + I + G + NX + NFF - IT

-D
➢ Where: C = Consumption, I = Investments, G =
Government spending, NX = Net exports (calculated
by subtracting imports from exports), NFF = Net
foreign factor income, IT = Indirect taxes, D =
25
Depreciation
❑ Personal Income = National Income

- Indirect Business Taxes
- Corporate Profits
- Social Insurance Contributions
- Net Interest
+ Dividends
+ Government Transfers to Individuals
+ Personal Interest Income
❑ Disposable Personal Income =
Personal Income - Personal Taxes.
➢ Disposable personal income is the amount households
and noncorporate businesses have available to spend
after satisfying their tax obligations to the government. 26
(GNP – GDP) as a percentage of GDP
selected countries, 2005
Phillippines 9.2%
Bangladesh 5.1
U.K. 2.2
U.S.A. 0.3 Japan 2.4%
Mexico -1.8
Russia -2.5 sources:
El Salvador -3.4 World Development Indicators,
World Bank
Argentina -5.4 and
Indonesia -6.5 Bureau of Economic Analysis,
U.S. Department of Commerce
Panama -7.3

National Income Accounts
❑ The national income accounts divide GDP into four
broad categories of spending:
▪ Consumption (C)
▪ Investment (I )
▪ Government purchases (G)
▪ Net exports (NX).
❑ Thus, letting Y stand for GDP,
➢ GDP is the sum of consumption, investment,
government purchases, and net exports.
Y = C + I + G + NX
❑ This equation is an identity—an equation that must
hold because of the way the variables are defined.
28
✓ It is called the national income accounts identity.
The Components of Expenditures
Y = C + I + G + NX
GDP Investment
= Total output/production spending by
= Total Income businesses and
= Total Expenditure households Net exports
Consumption Government
spending by purchases
households
National income accounts identity

Consumption (C)
definition: The value of all  durable goods
goods and services bought by last a long time
households. Includes: ex: cars, home
appliances
 nondurable goods
last a short time
ex: food, clothing
 services
work done for
consumers
ex: dry cleaning,
air travel.

Investment (I)
Definition 1: Spending on [the factor of production] capital.

Definition 2: Spending on goods bought for future use.
➢ Includes:
 business fixed investment
Spending on plant and equipment that firms will use to
produce other goods & services.
 residential fixed investment
Spending on housing units by consumers and landlords.
 inventory investment
The change in the value of all firms’ inventories.

Government purchases (G)
❑ G includes all government spending on goods and

services.
❑ G excludes transfer payments

(e.g., unemployment insurance payments),
➢ because they do not represent spending on goods
and services.

Net Exports (NX)
❑ NX accounts for trade with other countries.
❑ Net exports are the value of goods and services sold

to other countries (exports) minus the value of goods
and services that foreigners sell us (imports).
➢ Positive when the value of our exports is greater

than the value of our imports
➢ negative when the value of our imports is greater
than the value of our exports.

Summary
❑ Gross Domestic Product (GDP) measures both

total income and total expenditure on the
economy’s output of goods & services.
❑ Nominal GDP values output at current prices;

real GDP values output at constant prices.
Changes in output affect both measures,
but changes in prices only affect nominal GDP.
❑ GDP is the sum of consumption, investment,

government purchases, and net exports. 34

Summary
❑ The overall level of prices can be measured by

either
▪ the Consumer Price Index (CPI),
➢ the price of a fixed basket of goods
purchased by the typical consumer,
or
➢ the GDP deflator,
the ratio of nominal to real GDP.
❑ The unemployment rate is the fraction of the labor

force that is not employed. 35

Thank you!!
36
13 November 2023

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Topic 7

Mankiw: Macroeconomics, 9th edition, Chapter 2 13 November 2023

❑ Macroeconomics is the study of the economy as a

➢ Macroeconomists attempt both to explain economic

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❑ Two ways to view this statistic:

❑ To understand the meaning of GDP more fully, we turn to

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

Total expenditure on the economy’s output of goods and services

➢ Many goods are produced in stages: raw materials

➢ For example, suppose a cattle rancher sells one-

❖Should GDP include both the meat and the

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

➢ Intermediate Goods, Value Added and GDP

➢ Intermediate Goods, Value Added and GDP

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❑ The Treatment of Inventories

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❖Does this violate the expenditure = output identity?

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❖Why output = expenditure

▪ Unsold output goes into inventory,

➢ In effect, we are assuming that firms purchase their

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❑ Housing Services and Other Imputations

➢ Some goods are not sold in the marketplace and

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❑We have now seen that GDP measures

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❑ GDP is the value of all final goods and services

➢ Nominal GDP measures these values using current

➢ Real GDP measure these values using the prices of a

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

2014 2015 2016 2017

good A $30 900 $31 1,000 $36 1,050 $45 890

good B $100 192 $102 200 $100 205 $140 190

 Compute nominal GDP in each year.

nominal GDP multiply Ps & Qs from same year

❑ Changes in nominal GDP can be due to:

❑ Changes in real GDP can only be due to

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❑ The inflation rate is the percentage increase in the

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

2015 51,400 50,000

2016 58,300 52,000

2017 66,650 45,700

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e

Nominal GDP Inflation

2014 $46,200 $46,200 100.0 n.a.

2015 51,400 50,000 102.8 2.8%

2016 58,300 52,000 112.1 9.1%

2017 66,650 45,700 145.8 30.06

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e

❑ Nominal GDP measures the current dollar value of

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

❑ Gross Domestic Product (GDP): Total income

❑ Gross National Product (GNP): Total income earned

➢ GNP – GDP = factor payments from abroad –

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023

✓ GDP measures the total income produced

✓ GNP measures the total income earned by nationals

▪ For example, if a Japanese resident owns an

Copyright@2016 Worth Publishers. Macroeconomics, N Gregory Mankiw, 9e 13 November 2023