Definition of GDP

• GDP (Gross Domestic Product) is the market value of all

final goods and services produced in a country in a given
time period.
– Market value
• goods & services are valued at their market prices.
• GDP rises if prices rise (more on this later)
– Final goods and services
• Bought by final user
• Intermediate goods are produced by one firm, bought by
another, and used as a component of a final good or service.
• Exclude sale/purchase of intermediate goods to avoid double
counting.
 Definition of GDP
• Produced within a country
– Any domestic production, regardless of who owns the
resources
• In a given time period
– Production during a specific year (sales of used items
excluded, except value of service in sale)
– Inventory adjustments account for goods produced in
one year but sold in another
• if inventories rise by $10 million during 2010, $10 million is
added to sales of final goods & services since it reflects goods
produced but not sold during 2010.
• If inventories fall by $10 million during 2010, $10 million is
subtracted from sales of final goods & services because $10
million was sold during 2010 that was produced prior to
2010.
 GDP and Circular Flow
• Households sell factors of production the
firms in factor markets
– Factors of production: land, labor, capital
• Wages for labor
• Interest for loans used to purchase capital
• Rent for the use of land
• Profit to owners of capital
• Total income paid to households=Y
 What is ??? counted
• Fixing damage: Earthquake or storm
• Medical bills for lung damage due to bad air
 What is not counted
• Goods produced within the household
• Used goods sold in the market even if to final
buyers.
 GDP vs GNP
• GDP factors of production located within a
country
• GNP factors of production owned by a
country’s citizens, regardless of where the
output is produced.
 What GDP does not tell us
• Does not measure income distribution
• Does not measure non-monetary output or
transactions (e.g., barter, household
activities)
• Does not take into account desirable
externalities, such as leisure or environment
• Does not measure social well-being
• Correlates to standard of living but is not a
measure of standard of living
 Gross vs Net Domestic Product
• GDP is before subtracting depreciation (capital
consumption allowance)
• NDP =GDP- CCA
– NDP is “net of” depreciation.
• Capital in t = Capital in (t-1) + Gross Investment –CCA
= Capital in (t-1) + Net Investment
where Net investment = Gross investment – CCA
 If capital is $8 trillion at the end of 2008
and $7.7 trillion at the end of 2009
1. Gross investment is $.3
trillion in 2009
2. Gross investment is -$.3
trillion in 2009
3. Net investment is $.3 in
2009
4. Net investment is -$.3
trillion in 2009
0% 0% 0% 0%
1 2 3 10
4
 GDP: Adjusting for changes in prices
Nominal GDP
• the value of goods and services produced during a given
year valued at the prices that prevailed in that same year.
• Nominal GDP is a more precise name for GDP.

Real GDP
• the value of final goods and services produced in a given
year when valued at the prices of a reference base year.
 GDP Deflator
• GDP deflator
– Provides a comparison of current and base year
prices
Nominal GDP t
GDP - deflator t  x 100
Real GDP t
Methods To Measure GDP
 The Simple Circular Flow
• Final Goods and Services
– Goods and services that are at their final stage of
production and will not be transformed into yet other
goods or services
 The Simple Circular Flow

• Product Markets
– Transactions in which households buy goods
 The Simple Circular Flow
• Total Income
– Wages, rent, interest, profits
 The Simple Circular Flow
• Factor Markets
– Transactions in which businesses buy resources
 The Circular Flow
of Income and Product
 National Income Accounting
• National Income Accounting
– A measurement system used to estimate national
income and its components

• Total Income
– The yearly amount earned by the nation’s
resources (factors of production)
 National Income Accounting
• Gross Domestic Product (GDP)
– The total market value of all final
goods and services produced by
factors of production located within
a nation’s borders
– GDP measures the dollar value of
final output.
– GDP measures the dollar value of final goods and services
produced per year
by factors of production located within
a nation’s borders.
 National Income Accounting
(cont'd)
• Stress on final output
– What is a final good?
• Wheat?
• Steel?
• Oil?
• Bread?
• Automobile?
• Gasoline?
 National Income Accounting
(cont'd)
• Intermediate Goods
– Goods used up entirely in the production of final
goods

• Value Added
– The dollar value of an industry’s sales minus the
value of intermediate goods
(for example, raw materials and parts) used in
production
 National Income Accounting
 Numerous transactions occur that have nothing to do with
final goods and services being produced.
 Exclusion of financial transactions
Securities
 Stocks and bonds

Government transfer payments

 Social Security
 Unemployment compensation

Private transfer payments

 Individual gifts
 Corporate gifts
 National Income Accounting

• Transfer of secondhand
goods excluded
– Why not count the sale of a used computer, guitar,
or snowboard as part
of GDP?

• Other excluded transactions

– Household production
– Legal and illegal underground transactions
 National Income Accounting

• GDP’s limitations
– Excludes non-market production
– It is not necessarily a good measure of the well-
being of a nation.
– GDP is not a measure of a nation’s overall welfare.
– GDP is a measure of the value of production in
terms of market prices, and an indicator of
economic activity.
 Two Main Methods
of Measuring GDP
• Expenditure Approach
– Computing GDP by adding up the dollar value at
current market prices of all final goods and
services
 Two Main Methods
of Measuring GDP (cont'd)

Expenditure Approach
 Two Main Methods
of Measuring GDP (cont'd)
• Income Approach
– Measuring GDP by adding up all components of
national income, including wages, interest, rent,
and profits
 Two Main Methods
of Measuring GDP (cont'd)

Income Approach
 Two Main Methods
of Measuring GDP (cont'd)
• Deriving GDP by the expenditure approach
– Consumption Expenditure (C)
• Durable Consumer Goods
– Life span of more than three years
• Nondurable Consumer Goods
– Goods that are used up in three years
• Services
– Mental or physical help
 Two Main Methods
of Measuring GDP (cont'd)
• Deriving GDP by the
expenditure approach
– Gross Private Domestic Investment (I)
• The creation of capital goods, such as factories and
machines, that can yield production and hence
consumption in the future
– Also included: changes in business inventories and repairs
made to machines, buildings
 Two Main Methods
of Measuring GDP (cont'd)
• Deriving GDP by the expenditure approach
– Gross Private Domestic Investment (I)
• Producer Durables or Capital Goods
– Life span of more than three years
• Fixed Investment
– Purchases by business of newly produced producer durables or
capital goods
• Inventory Investment
– Changes in stocks of finished goods and goods in process, as well as
changes in raw materials
 Two Main Methods
of Measuring GDP (cont'd)
• Deriving GDP by the
expenditure approach
– Government Expenditures (G)
• State, local, and federal
• Valued at cost
– Net Exports (Foreign Expenditures)

Net exports (X) = Total exports – Total imports

 Two Main Methods
of Measuring GDP (cont'd)
• Presenting the expenditure approach
– Where
• C = consumption expenditures
•I = investment expenditures
• G = government expenditures
• X = net exports

GDP = C + I + G + X
 Two Main Methods
of Measuring GDP (cont'd)
• Depreciation and net domestic product
– Deducting for depreciation (capital consumption
allowance)
• Reduction in the value of capital goods over a one-year
period due to physical wear and tear, and also to
obsolescence

NDP = GDP – Depreciation

 Two Main Methods
of Measuring GDP (cont'd)
• NDP = GDP – Depreciation
• GDP = C + I + G + X
• NDP = C + I + G + X – Depreciation
• Net Investment = I – Depreciation
– Domestic investment minus an estimate
of the wear and tear on the existing
capital stock
• NDP = C + Net I + G + X
 Two Main Methods
of Measuring GDP (cont'd)
• Deriving GDP by the income approach
 Deriving GDP
by the Income Approach
• Gross Domestic Income (GDI)
– The sum of all income—wages, interest, rent, and
profits—paid to the four factors
of production
• Wages: salaries and labor income
• Rent: farms, houses, stores
• Interest: savings accounts
• Profits: sole proprietorships, partnerships, corporations
 Two Main Methods of Measuring GDP
• Gross domestic product equals gross domestic
income plus indirect business taxes and depreciation
• These last items are called non-income expense
items
• Indirect business taxes
– All business taxes except the tax on corporate profits
– Include sales and business property taxes
 Other Components of
National Income Accounting
• National Income (NI)
– The total of all factor payments to resource owners

• Personal Income (PI)

– The amount of income that households actually receive
before they pay personal income taxes

• Disposable Personal Income (DPI)

– Personal income after personal income taxes have been
paid
 Distinguishing Between Nominal
and Real Values
• Nominal Values
– Measurements in terms of the actual market
prices at which goods are sold; expressed in
current dollars, also called money values
 Distinguishing Between Nominal and Real Values
• Nominal Values
– Measurements in terms of the actual market prices at
which goods are sold; expressed in current dollars, also
called money values
• Real Values
– Measurements after adjustments have been made for
changes in the average
of prices between years; expressed in constant dollars

• Constant Dollars
– Dollars expressed in terms of real purchasing power
 Distinguishing Between Nominal
and Real Values (cont'd)
• Per capita GDP
– Adjusting for population growth

Real GDP
Per capita real GDP =
Population
 Comparing GDP Throughout the World
• Foreign Exchange Rate
– The price of one currency in terms
of another

• Foreign exchange rate & comparing GDP

• $1.25 = 1 euro, or $1 = 0.80 euros
• French per capita income = 23,168.80 euros
• French per capita income in terms of dollars equals
23,168.80 euros x $1.25 = $28,961