Macroeconomics: Gross

Domestic Product
Chapter
MICROECONOMICS vs. MACROECONOMICS

Microeconomics studies the decision Macroeconomics studies the behavior of the

made by individual and business whole economy
 THE PIZZA ECONOMY
• Let’s imagine that India produces only pizza

 Pizza is sold for ₹75

 Assume that each worker produces 1 pizza/hour

 Each worker works 40 hours/week and 50 weeks/year

 Again assume there are 100 workers in India

• Total economic activity is

 Total value of the pizzas produced in India

 40*50*100*75 = ₹ 15000000 per year

 Gross Domestic Product (GDP)

 Market value of all final goods and services within the country during a time period
 MARKET VALUE
• Previous example assumed that India only produces pizza

• Reality, millions of different goods and services are produced

 Ranging from haircuts to cars to missiles

• To capture the overall output of an economy

 One must add all the goods and services produced

 But, how to add cattles + liters of petrol + no. of cars

• We use market value

 Show individuals willingness to pay for different goods and services

 Value of a laptop is more than a t-shirt

 We assume market price as a proxy for market value

 FINAL GOODS AND SERVICES
• Only goods and services purchased by final users are included in GDP
• Intermediate goods such as raw materials are not included in GDP
• Example: Bottle of wine
 Wine sold to a consumer directly is a final good
 Wine sold to a restaurant is an intermediate good
• If both the sale were counted in GDP
• Then same bottle is counted twice
• To avoid double counting
 Exclude the sale of intermediate goods in GDP calculation
 TIME PERIOD
• GDP is reported on an annual basis
• This means we should exclude resale of goods and produced
• Example:
• If you purchase a new house
 It will be counted in GDP
• If you buy a 10-years old house
 It will not be counted in GDP
• However, the payment to the broker who showed you the old house
 Will be included in GDP
INDIAN STATES GDP EQUIVALENT TO
COUNTRY’S GDP
 WHAT ISN’T MEASURED BY GDP?
• GDP is a useful tool to measure total output in an economy
• But there are shortcomings of GDP

Exclude home production Exclude informal activity

Exclude pollution

Source: Macroeconomics, Acemoglu, Laibson, List

 IS GDP A GOOD MEASURE OF OUR WELL-
BEING
• It is not a good measure of well-being
• GDP per capita = GDP/Population
• Example: U.S. work week has declined from 60 hours to 40 hours
• Decreases GDP but increases well-being

• Compare people’s happiness to GDP

• https://ourworldindata.org/grapher/gdp-vs-happiness?stackMode=absolute&time=2016
 CALCULATING GDP IN THREE DIFFERENT
WAYS
• GDP can be measured in three different ways:
 Production approach
 Product of quantity of product and market price of each product
 Expenditure approach
 Adding up the sales of the products
 Income approach
 Adding up the input (labor, capital etc.) payments
• Production = Expenditure = Income
 PRODUCTION APPROACH
Sector 1990-91 (in crores) 2004-05
PRIMARY 33.5 22.1
1) Agriculture 28.3 17.6
2) Forestry & Fishing 2.7 1.9
3) Mining & Quarying 2.5 2.6
SECONDARY 26.9 24.7
4) Manufacturing 18.7 15.8
5) Electricity, gas and water 2.2 2.6
6) Construction 6.0 6.1
TERTIARY 39.7 53.3
7) Trade, hotels and restaurant 13.0 16.2
8) Transport 7.1 8.5
9)Banking and insurance 4.4 5.8
10)Real estate, dwellings 3.7 8.5
11) Public adm. And defense 5.7 6.1
12) Other services 5.8 8.2
GDP at Market price 33.5+26.9+39.7 22.1+24.7+53.3
 INCOME APPROACH

Items Amount in crs.

Wages 10000
Rent 5000
Interest 400
Dividend 3000
Mixed income 400
Undistributed profits 200
Social Security contributions 400
Corporate Profit tax 400
 EXPENDITURE APPROACH
• Four components:
• Consumption (C): Total spending by households
• Investment (I): Total spending on goods that will be used in the future to produce
more goods
• Government Purchases (G): Total spending on goods and services purchased by the
government
• Net Exports (NX): Exports (X) – Imports (M)
• These components add up to GDP (Y)
• Y=C+I+G+X–M
 CAN YOU CALCULATE GDP USING
EXPENDITURE APPROACH?
Category Amount
Durable Goods $1,000
Non-Durable $2,500 • GDP = C + I+ G + E – M
Goods
• C = $1,000 + $2,500 + $7,000 = $10,500
Services $7,000
• I = $1,800 + $35 = $1,835
Fixed Investment $1,800
Changes to $35 • G = $3,000
Inventories
• NX = E – M = $2,000 – $2,600 = -$600
Investments in $5,500
Stocks • GDP = $10,500 + $1,835+ $3,000 – $600
Government $3,000 = $14,735
Purchase
Transfer $575
Payments
Exports $2,000
Import $2,600
 PRACTICE QUESTIONS
A. Debbie spends $300 to buy her husband dinner at the finest restaurant in Boston
B. Sarah spends $1200 on a new laptop to use in her publishing business. The laptop was built in
China
C. Jane spends $800 on a computer to use in her editing business. She got last year’s model on sale
for a great price from a local manufacturer
D. General Motors builds $500 million worth of cars, but consumers only buy $470 million worth
of them

• Consumption and GDP rise by $300

• Investment rises by $1200, net exports fall by $1200, GDP is unchanged
• Current GDP and investment do not change, because the computer was built last year
• Consumption rises by $470 million, inventory investment rises by $30 million, and GDP rises by
$500 million
 COMPONENTS OF GDP
• U.S. GDP Shares (1929–2013)
 REAL vs. NOMINAL GDP

• Nominal GDP
 Values output using current prices
 Not corrected for inflation
• Real GDP
 Values output using a base-year prices
 Is corrected for inflation
• For the base year Nominal GDP = Real GDP
 REAL vs. NOMINAL GDP
Pizza Latte
year P Q P Q
2014 $10 400 $2.00 1000
2015 $11 500 $2.50 1100
2016 $12 600 $3.00 1200

• Nominal GDP in 2014: $10 x 400 + $2 x 1000 = $6,000

• Nominal GDP in 2015: $11 x 500 + $2.50 x 1100 = $8,250

• Let’s assume 2014 as the base year

• Real GDP in 2015: $10 x 500 + $2 x 1100 = $7,200
 GDP DEFLATOR
GDP
Nominal Real
year GDP GDP Deflator
2014 $6000 $6000 100.00
2015 $8250 $7200 114.6
2016 $10800 $8400 128.6

• Measure of overall level of prices

𝑁𝑜𝑚𝑖𝑛𝑎𝑙
• GDP deflator = 100 X
𝑅𝑒𝑎𝑙
 PRACTICE QUESTION
2014 (base year) 2015 2016
P Q P Q P Q
Good A $30 900 $31 1000 $36 1050
Good B $100 192 $102 200 $100 205

A. Compute nominal GDP in 2014.

B. Compute real GDP in 2015.
C. Compute the GDP deflator in 2016.