Macroeconomics / Makroekonomia

Block 1
Chapter 21
GDP & Economic Growth
Summer 2024

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Measuring GDP & Economic Growth

◆ Define GDP and its main parts

◆ Understand the circular flow system

◆ Introduce economic growth

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 Gross Domestic Product

GDP Defined
GDP or gross domestic product is the market value of
all final goods and services produced in a country in a
given time period.

This definition has four parts:

▪ Market value
▪ Final goods and services
▪ Produced within a country
▪ In a given time period

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Gross Domestic Product

Market Value
GDP is a market value—goods and services are valued at
their market prices.

Produced within a Country

GDP measures production within a country—domestic
production.

In a Given Time Period

GDP measures production during a specific time period,
normally a year or a quarter of a year.

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 Gross Domestic Product
Final Goods and Services

GDP is the value of the final goods and services produced.

A final good (or service) is an item bought by its final user

(consumer) during a specified time period.

A final good contrasts with an intermediate good, which

is an item that is produced by one firm, bought by another
firm, and used as a component in a final good or service.

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Gross Domestic Product

GDP and the Circular Flow of Expenditure and Income
GDP measures the value of production, which also equals
total expenditure on final goods and total income.
Two sides to understanding GDP:
1. Production of goods and services
2. Income derived from the sales of goods and services

Note: GDP/Capita (output per head / income per head)

The equality of income and value of production shows the
link between productivity and living standards.
This means that standards of living rise when income rises.
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 Gross Domestic Product
What does the circular flow diagram show?
The circular flow diagram shows the transactions among
households, firms, governments, and the rest of the world.

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Gross Domestic Product

Households
Households sell and firms buy the services of labour, capital,
and land in factor markets.

What are the four factors of production?

Answer: L, L, C, E

Firms pay wages for labor services, interest for the use of
capital, and rent for the use of land.
A fourth factor of production, entrepreneurship, receives profit.
In the following figure, the blue flow, Y, shows total income
paid by firms to households.
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 Gross Domestic Product

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Gross Domestic Product

Firms sell and households buy consumer goods and services
in the goods market.
We therefore have:
* Factor Markets
* Goods Markets
Consumption expenditure is the total payment for consumer
goods and services.
Firms buy and sell new capital equipment in the goods market
and put unsold output into inventory.
These purchases of new capital equipment and the additions to
inventories are investment, shown by the red flow labeled.

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 Gross Domestic Product

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Gross Domestic Product

Governments
Governments buy goods and services from firms and their
expenditure on goods and services is called government
expenditure.
Government expenditure is shown as the red flow G.
Governments finance their expenditure with taxes and pay
financial transfers to households, such as unemployment
benefits, and pay subsidies to firms.
These financial transfers are not part of the circular flow of
expenditure and income.

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 Gross Domestic Product

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Gross Domestic Product

Governments
1. Governments employ and pay staff across several
departments in different sectors.
2. Governments spend on critical sectors: health,
education, defence and national security.
3. So, when NATO advises its members to spend 2% of
its GDP on defence you can easily calculate for
example how much your country spends.
4. Government expenditure is financed through taxation.
In this world nothing can be said to be certain, except
death and taxes, Benjamin Franklin (1789).

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 Gross Domestic Product
Rest of the World
Firms in the United States sell goods and services to the
rest of the world—exports—and buy goods and services
from the rest of the world—imports.
The value of exports (X ) minus the value of imports (M) is
called net exports, the red flow (X – M).
If net exports are positive, the net flow of goods and
services is from U.S. firms to the rest of the world. Trade
surplus.
If net exports are negative, the net flow of goods and
services is from the rest of the world to U.S. firms. Trade
deficit.
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Gross Domestic Product

The sum of the red flows equals the blue flow.

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 Gross Domestic Product

That is: Y = C + I + G + X – M

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• Note, in English we have thousands, millions, billions and trillions.

• GDP was over $18 trillion ($18.569 trillion).
• Consumption accounted for 68.7% of GDP.
• Firms invested $3 trillion and the government spent $3.277 trillion.
• The trade balance with the rest of the world was negative.
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 The Basics of Economic Growth
Economic growth is the sustained expansion of production
possibilities measured as the increase in real GDP over a
given period.
Calculating Growth Rates
The economic growth rate is the annual percentage change
of real GDP.
The economic growth rate tells us how rapidly the total
economy is expanding. We can also compare – for example:
• Over the past forty years real GDP tripled (increased three-
times) in the US
• In China the rate of growth has tripled over sixteen years.
• Hence, the Chinese economy is growing 2.5 times faster
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The Basics of Economic Growth

However, the standard of living depends on real GDP per
person.
Real GDP per person is real GDP divided by the population.

Real GDP per person grows only if real GDP grows faster
than the population grows.

Some additional points:

• Real GDP per person is a measure of income per head
• Real GDP person is a measure of output per head
• Real GDP per person is the best measure of welfare
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 The Basics of Economic Growth
Economic Growth
Real GDP can increase for two distinct reasons:
1. The economy might be returning to full employment in
an expansion phase of the business cycle.
* The return to full employment in an expansion phase of
the business cycle isn’t economic growth – it’s a recovery.

2. Potential GDP might be increasing.

The expansion of potential GDP is economic growth.
* This is year-on-year growth.

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The Basics of Economic Growth

Figure 23.1 illustrates the
distinction.
A return to full employment
in an expansion is a
movement from inside the
PPF to a point on the PPF:
from point A to point B.
Economic growth is the
outward shift of the PPF
from PPF0 to PPF1 :
from point B to point C.

A = Unattainable B = Utilizing Potential C = Growth & Expansion

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 The Basics of Economic Growth

The figure shows the 3. Points B to C on the PPF

growth rate of real GDP.
2. Point B on the PPF
The growth rate of
potential GDP measures
the pace of expansion of
production possibilities
and …
smooths out the business 1. Point A on the
cycle fluctuations in the PPF
growth rate of real GDP.

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Review questions
1. What is the definition of GDP?

2. What are the main factors of production?

3. What does the standard of living depend on?

4. When does economic expansion occur?

5. What does the economic growth rate tell us?

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