GDP

Measuring a Nations Income
Principles of Macroeconomics: Ch 10
Second Canadian Edition
Overview
Why an economys total income equals

its total expenditure.
How gross domestic product (GDP) is
defined and calculated.
Breakdown GDP into its four major
components.
Distinguish between real and nominal
GDP and see if GDP measures economic
well-being.
Macroeconomics
Macroeconomics is the study of the
economy as a whole. Its goal is to
explain the economic changes that affect
many households, firms, and markets at
once.
Microeconomics is the study of how
individual households and firms make
decisions and how they interact with one
another in markets.
Understanding the Economy

Identify the important areas:
Total output (and income)

The average of prices
Resource employment
Measure the important areas using:
Real Gross Domestic Product

Consumer Price Index
Monthly unemployment rate
The Circular-Flow Diagram

Product Market
$
Households
Businesses
$
Market for Factors
of Production
$
Figure 1 The Circular Flow
MARKETS
FOR
GOODS AND SERVICES
Firms sell
Goods
Households buy
and services
sold
Revenue
Wages, rent,
and profit
Goods and
services
bought
HOUSEHOLDS
Buy and consume
goods and services
Own and sell factors
of production
FIRMS
Produce and sell
goods and services
Hire and use factors
of production
Factors of
production
Spending
MARKETS
FOR
FACTORS OF PRODUCTION
Households sell
Firms buy
Labor, land,
and capital
Income
= Flow of inputs
and outputs
= Flow of dollars
6
Copyright 2004 South-Western
Two Methods of Computing

An Economys Income
Expenditure Approach:
Sum the total expenditures by households

(from the top portion of the circular flow).
Resource Cost or Income Approach:
Sum the total wages and profit paid by firms

for resources (from the bottom portion of the
circular flow).
The Economys
Income and Expenditure
When judging whether the economy is
doing well or poorly, it is natural to look at
the total income that everyone in the
economy is earning.
For an economy as a whole, income must
equal expenditure.
The forces of supply and demand
determine the market equilibrium price and
quantity that is produced and exchanged.
Overview

components.
well-being.
The Economys
Income and Expenditure
A measure of the income and
expenditures of an economy is Gross
Domestic Product (GDP).
Gross Domestic Product measures:
an economys total expenditure on newly

produced goods and services and the total
income earned from the production of these
goods and services.
Gross Domestic Product

The total market
value of all final
goods and services
produced during a
given period of
time within a
country, region, or
province.
Important Features of GDP

Output is valued at market-determined
prices.
Output is measured in dollar terms.
GDP records only the output of final
goods. We want to count production
only once.
Represents the amount of money one
would need to purchase a years worth of
the economys production of all final
goods.
What Is and What Is Not

Counted in GDP?
GDP includes all items produced in
the economy and sold legally in
markets.
GDP does not include items
produced and consumed at home
that never enter the marketplace. It
does not include items produced and
sold illicitly, such as illegal drugs.
Gross National Product

The total market value
of all final goods and
services produced
during a given period
of time by the
nations residents,
regardless of the
place produced.
Quick Quiz!
Which contributes
more to GDP: the
production of a pound
of hamburger or the
production of a pound
of caviar? Why?
Three Other Measures of

Income
Net National Product (NNP):
Total income of residents of a nation after

subtracting capital consumption allowances.
Personal Income:
The income that households and noncorporate businesses receive.
Disposable Personal Income:
The income that households and noncorporate businesses have left after taxes.
SecondEdition
Canadian Edition
First Canadian
Overview

components.
well-being.
The Components of GDP

GDP (Y) is the sum of:
Consumption (C)
Investment (I)
Government Purchases (G)
Net Exports (NX)
Y = C + I + G + NX
The Four Components of

GDP
Consumption (C):
Is the spending by households on goods

and services
e.g. buying clothing, food, movie tickets
Investment (I):
Is the purchases of capital equipment

and structures
e.g. factory, houses, etc.
The Four Components of

GDP (G):
Government Purchases
Includes spending on goods and services by

local, provincial and federal governments
(e.g. roads, police, etc.).
Does not include transfer payments,
because it is not made in exchange for
currently produced goods or services.
Net Exports (NX):
Exports minus imports.
GDP Components of
Measurement
GDP Components of
Measurement
Consumption
57%
GDP Components of
Measurement
Investment
Consumption
17%
57%
GDP Components of
Measurement
Government
Purchases
21%
Investment
Consumption
17%
57%
GDP Components of
Measurement
Net Exports
Government
Purchases
5%
21%
Investment
Consumption
17%
57%
Quick Quiz!
List the four
components of
expenditure.
Which is the
largest?
Overview

components.
well-being.
1) To compute the total value of different goods and services, the

national income accounts use market prices.
Thus, if
$0.50
$1.00
GDP = (Price of apples Quantity of apples)

+ (Price of oranges Quantity of oranges)
= ($0.50 4) + ($1.00 3)
GDP = $5.00
2) Used goods are not included in the calculation of GDP.
3) 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).
28
4) Intermediate goods are not counted in GDP only the value of

final goods. Reason: the value of intermediate goods is already
included in the market price. Value added of a firm equals the
value of the firms output less the value of the intermediate goods
the firm purchases.
5) Some goods are not sold in the marketplace and therefore dont
have market prices. We must use their imputed value as an estimate
of their value. For example, home ownership and government services.
29
Lets see how real GDP is computed in our apple and

orange economy.
For example, if we wanted to compare output in 2002 and output
in 2003, we would obtain base-year prices, such as 2002 prices.
Real GDP in 2002 would be:
(2002 Price of Apples 2002 Quantity of Apples) +
(2002 Price of Oranges 2002 Quantity of Oranges).
30
31
GDP Deflator = Nominal GDP

Real GDP
Nominal GDP measures the current dollar value of the output of
the economy.
Real GDP measures output valued at constant prices.
The GDP deflator, also called the implicit price deflator for GDP,
measures the price of output relative to its price in the base year. It
reflects whats happening to the overall level of prices in the economy.
32
Real versus Nominal GDP

GDP is the market value of the
economys current production, referred
to as Nominal GDP.
Real GDP measures any given years
total output in constant prices.
An accurate view of the economy
requires adjusting nominal to real GDP,
using the GDP Price Deflator.
GDP Price Deflator

The GDP Price Deflator is a price index
that uses a bundle of all final goods and
services.
It tells us the rise in nominal GDP that is

attributable to a rise in prices.
Converting Nominal GDP to Real GDP:

Real GDP20xx =
(Nominal GDP20xx ) (GDP deflator20xx)X100
Quick Quiz!
Define Real and
Nominal GDP.
Which is a better
measure of
economic wellbeing? Why?
GDP and Economic Well-Being

GDP Per Person tells us the income and
expenditure of the average person in the
economy.
It is a good measure of the material wellbeing of the economy as a whole.

More Real GDP means we have a higher
material standard of living by being able to
consume more goods and services.
It is NOT intended to be a measure of
happiness or quality of life.
GDP and Economic Well-Being

Some factors and issues not in GDP that
lead to the well-being of the economy:
Factors that contribute to a good life such as

leisure.
Factors that lead to a quality environment.
The value of almost all activity that takes
place outside of the markets, e.g. volunteer
work and child-rearing.
Overview

components.
well-being.
Y
Y == CC ++ II ++ G
G ++ NX
NX
Totaldemand
demand
Total
fordomestic
domestic
for
output(GDP)
(GDP)
output
composed
isiscomposed
of
of
Investment
Investment
spendingby
by
spending
businessesand
and
businesses
households
households
Consumption
Consumption
spendingby
by
spending
households
households
Government
Government
purchasesof
ofgoods
goods
purchases
andservices
services
and
Netexports
exports
Net
ornet
netforeign
foreign
or
demand
demand
This is the called the national income accounts identity.

39
40

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GDP

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Measuring a Nations Income

Second Canadian Edition

Why an economys total income equals

Second Canadian Edition

Second Canadian Edition

Understanding the Economy

Total output (and income)

Measure the important areas using:

Real Gross Domestic Product

Second Canadian Edition

The Circular-Flow Diagram

Figure 1 The Circular Flow

Two Methods of Computing

Sum the total expenditures by households

Resource Cost or Income Approach:

Sum the total wages and profit paid by firms

Second Canadian Edition

Second Canadian Edition

Why an economys total income equals

Second Canadian Edition

an economys total expenditure on newly

Second Canadian Edition

Gross Domestic Product

Second Canadian Edition

Important Features of GDP

Second Canadian Edition

What Is and What Is Not

Second Canadian Edition

Gross National Product

Second Canadian Edition

Second Canadian Edition

Three Other Measures of

Total income of residents of a nation after

The income that households and noncorporate businesses receive.

Disposable Personal Income:

Why an economys total income equals

Second Canadian Edition

The Components of GDP

Second Canadian Edition

The Four Components of

Is the spending by households on goods

Is the purchases of capital equipment

Second Canadian Edition

The Four Components of

Includes spending on goods and services by

Net Exports (NX):

Exports minus imports.

Second Canadian Edition

Second Canadian Edition

Second Canadian Edition

Second Canadian Edition

Second Canadian Edition

Second Canadian Edition

Second Canadian Edition

Why an economys total income equals

Second Canadian Edition

1) To compute the total value of different goods and services, the

GDP = (Price of apples Quantity of apples)

Second Canadian Edition

4) Intermediate goods are not counted in GDP only the value of

Second Canadian Edition

Lets see how real GDP is computed in our apple and