Chapter 5

Measuring Economic Activity: GDP

and Unemployment

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distribution without the prior written consent of McGraw-Hill Education.
 Recent FT article on Turkish
Growth
•

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• Link for the article:
• https://www.ft.com/content/c038cf70-
5a32-491b-a113-2e20a83af951

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 Measuring Output

Gross Domestic Product (GDP) is

The market value of

Final goods and services

Produced in a country in a given

period of time

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 Market Value
• Aggregate measure of quantities produced
• More expensive items receive a higher
weighting
– Willingness to pay is an indication of benefit
received from the good
Apples Bananas Shoes
Price $0.25 $0.50 $20.00
Quantity 4 6 3
GDP contribution $1.00 $3.00 $60.00

• The country's GDP is $64

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 Final Goods and Services
• Final goods and services are consumed by the ultimate
user
– End products of production
– Included in GDP
• Intermediate goods and services are used up in the
production of final goods
– Not included in GDP to avoid double counting

Example:
• The milk that you buy from the market is a final good
included in the GDP
• The milk that a pastry shop buys to make pudding is an
intermediate good and not included in the GDP.
–

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 Goods Can Be Final and
Intermediate
• Milk can be sold as a final product or used as an
intermediate good
– Gallons of milk in the store
– Gallons of milk sold to restaurants
– Count only the final goods

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 One exception to double-
counting
• A capital good is a long-lived good used in the
production of other goods and services
– Plant and equipment in factories
– Stoves in restaurants, cooking schools
– Delivery vehicles and taxis
– Houses, apartments, and motels

• Money is not a capital good

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 Value Added
• Value added is the market value of the
product minus the cost of inputs
purchased from other firms
– Count value added in the year it is produced
– Hot'n'Fresh buys flour and other inputs to
make bread that sells for $2.00
Cost of Purchased Value
Company Revenues
Inputs Added
ABC Grain $0.50 $0.00 $0.50
General Flour $1.20 $0.50 $0.70
Hot'n'Fresh $2.00 $1.20 $0.80
Total $2.00
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 Produced in a Country in a
Period of Time
• "Domestic" in GDP means the activity is
measured within a country's borders
– Nationality of owners or company is not relevant
• Value must be produced in the year considered
– Sell a 20-year old house for $200,000
• Pay $12,000 commission
• Value added is $12,000
• House was not produced in the period of time studied
• Count income generated from the sale of used goods

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 3 approaches to calculate GDP
• GDP can be measured in three ways:
– Market value of all final goods produced
– Total spending for final goods less value
of imports
– Total income generated in an economy

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 Expenditure Method for
Measuring GDP
• Four users of final goods
▪ Households ■ Firms
▪ Government ■ Foreigners
• All goods produced are purchased by
one of these groups in a given year
• Amount spent = market value

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 US GDP, 2016 (billions of dollars)
Consumption $12,820.7
Durable Goods $1,411.0
Non-durable Goods 2,710.4
Services 8,699.3
Investment 3,057.2
Business Fixed Investment 2,316.3
Residential 705.9
Inventory 35.1
Government Purchases 3,267.8
Net Exports – 521.2
Exports 2,214.6
Imports 2,735.8
GDP $18,624.5
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Going back to the FT article
(Feb 28, 2023)

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 Consumption Expenditure
• Consumption expenditure is spending by
households for goods and services
– Consumer durables are long-lived consumer
goods
■ Cars ■ Furniture ■ Appliances

– Consumer non-durable goods are shorter-lived

goods
■ Clothing ■ Food ■ Bedding

– Services are the largest component of consumer

spending
■ Education ■ Taxi rides ■ Haircuts

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 Investment
• Investment is spending by firms on final goods
and services
• Business fixed investment is purchases of new
capital goods
■ Plant ■ Property ■ Equipment

• Residential investment is construction of new

homes and apartment buildings
• Inventory investment is the change in unsold
goods to the company's inventory
– These goods are produced but not yet sold
– This entry can be positive or negative

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Decomposition of Investment in
Turkey

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 Economic Investment and
Financial Investment
• Financial investment
– Purchases of stocks, bonds, and other financial
assets
– Purchase generally transfers ownership of a
portion of the firm's existing capital stock
– Does not correspond to any increase in physical
capital or production capacity, in most cases
• New stock issues can be an exception
• Economic investment: the increase in the
capital goods used to produce other goods
– This value is based on the purchase price of the
capital goods, not on stock value

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 Government Purchases
• Government purchases are final goods and
services bought by the government
■ Fighter jets ■ Teaching ■ Office Supplies

• Excludes transfer payments

– Transfer payments are made by government but the
government receives no current goods or services
■ Social Security ■ Food Stamps

• No purchases of final goods and services

involved in transfer payments
– Spending by recipients is included in GDP
• Excludes interest paid on government debt

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 Net Exports
• Net exports equal exports minus imports
– Exports are goods and services produced
domestically and sold abroad
• Exports reduce the amount available to the
domestic economy
– Imports are purchases of goods and services
produced abroad
• Imports can be consumption, investment, or
government spending
• Imports increase the amount available to the
domestic economy

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 GDP Expenditures Equation
Terminology
Y Gross Domestic Product or output
C Consumption Expenditure
I Investment
G Government Purchases
NX Net Exports
• Expenditure approach to measuring GDP

Y = C + I + G + NX
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 GDP Example
• An economy produces 1,000,000 cars
valued at $15,000 each.
– 700,000 are sold to consumers
– 200,000 are sold to businesses
– 50,000 are sold to the government
– 25,000 are sold abroad
• Notice: 25,000 cars are left unsold
• (Assume there is no stocks carried over from the earlier years).

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 GDP Example
• Total production is 1 million cars, $15,000 each
• Production value is 1 million times $15,000 = $15
billion
Sector # Cars Purchased GDP Contribution
Consumers 700,000 $10.500 billion
Investment
Businesses 225,000
200,000 $3.375
$3.000 billion
billion
Government 50,000 $0.750 billion
Net exports 25,000 $0.375 billion
Total
Total 1,000,000
975,000 $14.625
$15.000 billion
billion

– 25,000 cars are unsold

– Investment in inventories increases by $0.375 billion

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 Question
• Given the data in the table, compute the
value of GDP.

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• C=$1000
• I=500+300+100
• G=700
• NX=500-600=-100
• Y=C+I+G+NX=2500

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 Income Approach to GDP
• When a good is sold, its proceeds are distributed
to workers or business owners
• GDP = labor income + capital income
• Labor income is wages, salaries, benefits, and
incomes of the self-employed
– About ⅔ of GDP
• Capital income pays for physical capital and
intangibles
• Profits for business owners • Rent for land
• Interest for bond holders • Royalties
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 The Three Faces of GDP
Production Expenditure Income
Government
purchases
Investment
Market Value Labor
of Final Goods Income
and Services
Consumption

Capital
+ Income
- Net exports
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 Adjusting for Price Changes
• Compare GDP for different years to see
how much output has changed
• GDP changes over time because
– Prices change AND
– Quantity of output changes
• To see how much output has grown,
use only the changes in quantities
– Hold prices constant

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The Pizza and Calzone Economy
• GDP in 2013 is $175; GDP in 2017 is $420
– GDP in 2017 is 2.4 times the GDP in 2013
• Only twice as many pizzas and calzones
were produced in 2017
– Market value of output grew faster than the
physical volume of output
Number of Price of Number of Price of
Pizzas Pizza Calzones Calzones
2013 10 $10 15 $5
2017 20 $12 30 $6

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 Real GDP and Nominal GDP
• Real GDP values output in the current
year using the prices from the base year
– The base year is a reference year that
changes infrequently
– Real GDP measures the physical volume of
production
• Nominal GDP values output in the current
year using prices from the current year
– Nominal GDP is the current dollar value of
production

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 Calculating Real GDP for 2017
• Use 2013 as the base year
• Nominal GDP for 2013 is $175 and for 2017, $420
• Calculate real GDP using current year quantities and
base year prices
– Real GDP in 2017 is
(20 pizzas) ($10) + (30 calzones) (5) = $350
• Real GDP doubled between 2013 and 2017

Number of Price of Number of Price of

Pizzas Pizza Calzones Calzones
2013 10 $10 15 $5
2017 20 $12 30 $6
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Nominal and Real GDP in Turkey

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 Observations on Real and
Nominal GDP
• Usually, nominal and real GDP increase each year
• Nominal GDP can go up and real GDP go down
– Fewer goods and services produced AND
– Prices increase faster than output decreased
• Nominal GDP will be smaller than real GDP if the
prices in the current year are less than in the base
year
– Usually true for years before the base year
• Real GDP could rise and nominal GDP fall, but this is
rare
– Prices are falling faster than output is increasing

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 Real GDP and Economic
Well-Being
• Real GDP is a flawed measure of well-
being
– It values only market transactions
• Omits illegal transactions, volunteer work, and
household production
• Maximizing GDP will not necessarily
maximize national well-being
– Whether increases in output increase
welfare is a case-by-case issue

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 GDP Does Not Value Leisure
• Amount of leisure time has increased in
the past 100 years
– Work weeks are shorter
– People enter the labor force at an older age
– People retire earlier
• Leisure produces no goods for market
– GDP places a value of zero on all leisure time
– Opportunity cost of an hour of leisure is your
hourly wage
– Omission of the value of leisure time makes
GDP seem smaller

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 Environmental Quality
• Suppose a factory is built in your town
– People are employed and output is produced
• Productive activity is included in GDP
• Suppose further that the factory creates
pollution
– Your city hires a company to restore the
environment to its initial condition
– Clean-up activities are included in GDP
• Gets environment back to its starting point, not
better

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 Resource Depletion
• No adjustment is made for the decline
in resource availability when mining or
other harvesting is done
– One more barrel of oil on the market
means one less barrel for future use
• Environmental quality and resource
depletion are difficult to value
– They have value and that value is omitted
from GDP
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 Poverty and Economic
Inequality
• GDP does not capture the effects of
income inequality
– Most would prefer living in a relatively
equal society to one with a few wealthy
and many poor

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 World Bank Report highlights
increasing poverty levels in Turkey:
• https://www.worldbank.org/en/country/turkey/publication/economic-
monitor

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 Unemployment
• Statistical agencies estimate employment and
unemployment monthly
Population Age 16+

Unemployed
Out of
the
Employed
Labor
Force

• Labor force = employed + unemployed

• Unemployment rate = unemployed / labor force
• Participation rate = labor force / population 16+
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 U.S. Employment Data

U.S. Employment Data, July 2017 (in millions)

Employed 153.51 million
Unemployed 6.98 million
Labor Force 160.49 million
Not in the Labor Force 94.66 million
Working-Age Population 255.15 million
Unemployment Rate 4.3%
Participation rate 62.9%

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Turkish Employment Data

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 U.S. Unemployment Rate, 1965 -
2019

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Interactive Chart at: https://www.bls.gov/charts/employment-situation/civilian-unemployment-rate.htm
Turkish Unemployment Rate

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 Costs of Unemployment
• Economic costs
– Lost wages and production
– Decreased taxes and increased transfers
• Psychological costs
– Individual self-esteem
– Family stress of decreased income and
increased uncertainty
• Social costs
– Potential increases in crimes and social
problems
• Social resources spent to address these

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 Duration of Unemployment
• Long-term unemployed have been out of
work for 6 months or longer
• Short-term unemployed have several
possible outcomes
– Find a permanent job after searching a few
weeks
• Economic costs are low
– Leave the labor force
– Short-term or temporary job that leads to
unemployment again
• These chronically unemployed have costs similar to
the long-term unemployed

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 Other Unemployment Issues
• Discouraged workers would like to have a job but
they have not looked for work in the past four weeks
because they believe there are no jobs available
– Counted as out of the labor force
– Could be counted as unemployed but they are
not
• Involuntary part-time workers are people who like
to work full-time but cannot find a full-time job
– Counted as employed
• July 2017 unemployment rate was 4.3%
– Including discouraged workers and involuntary
part-time workers would make the rate 8.6%

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 Announcements

• Answers to the end of chapter problems

are posted online

• You can solve all questions but 9, 10,12

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Problem 1

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(300 fish)(1 clamshell per fish) +
(5 boars)(10 clamshells per boar) +
(200 bunches of bananas)(5 clamshells per bunch of
bananas)
= 300 + 50 + 1,000
= 1,350.

• John digging bait for George represents an

intermediate service that is not counted in GDP.
Similarly, George’s purchase of mature banana
trees does not count in GDP since the trees are an
existing asset.

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Problem 2

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Problem 4

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a) Value-added for 2014 is shown in the following table:
a) Value added for 2014 is shown in the following table:
Cost of purchased Value
Company Revenues
inputs added
MNLogs 1,500 0 1,500
MNLumber 4,000 1,500 2,500
MNFurniture 7,000 4,000 3,000

b) The increase in GDP for 2014 equals the sum of the value added, which is
$1,500 + $2,500 + $3,000 = $7,000

c) Value-added for 2014 is shown in the following table:

Cost of purchased Value

Company Revenues
inputs added
MNLogs 1,500 0 1,500

d) Value-added for 2015 is shown in the following table:

Cost of purchased Value

Company Revenues
inputs added
MNLumber 4,000 1,500 2,500
MNFurniture 7000 4000 3000

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Enf of chapter questions

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