Chapter 07

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distributed with certain product , service, or otherwise on password-protected
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In This Lecture…..
Gross Domestic Product

Expenditures
Computing GDP
Measurements Other Than
GDP
Real GDP
Economic Growth and • To select a topic, click on its link
Business Cycles above
© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned,
or duplicated, in whole or in part, except for use as permitted in a license
Gross Domestic Product
(GDP)
The total market value of all

final goods and services
produced annually within a
country’s borders.
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Ways to Compute GDP -
Expenditure Approach
 Add the amount of money spent by buyers of final goods
and services*
 Avoid double counting.
 Do not count intermediate goods**
* Goods in the hands of their final users.

** Goods that are inputs for the production of final
goods.
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*Ways to Compute GDP
Income and Value –added Approaches
 Income Approach – add the sum of all incomes earned

(wages, interest, rents, and profits) in producing goods and
services
 Value-added Approach – add the value added at each
stage of production of all goods and services
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What’s Not Included in GDP
Certain non-market goods and

services such as chores
performed at home by family
members.
Underground activities, both
legal and illegal such as legal
unrecorded activities paid for in
cash or illegal gambling
Sales of used goods
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What’s Not Included in GDP
 Financial transactions such as trading

of stocks and bonds
 Government transfer payments , a
payment to a person that is not for
goods and services currently supplied
such as social security
 Leisure time
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GDP and Bads
 GDP counts the

goods and services,
but it does not net out
the air and water
pollution.
 Thus, some
economists argue that
GDP overstates our
overall economic
welfare.
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GDP Per Capita
Click above to view data from the CIA Fact

Book on per capita GDP for countries
around the world
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Self-Test
1. Why aren’t stock purchases and sales

counted in GDP?
GDP is a measure of production in a country. When stocks are
purchased and sold, no production occurs. A stock purchase and
sale simply represent the trading of existing assets. Specifically, if
person A owns 100 shares of stock X and then sells the shares to
person B, all that has happened is that person B owns something
that person A once owned. No more goods and services have
been produced.
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Self-Test
2. Suppose the GDP for a country is $0. Does

this mean that there was no productive
activity in the country? Explain your answer.
No. GDP doesn’t account for all productive activity (e.g., it omits the
production of nonmarket goods and services). Even if GDP is $0, it
doesn’t necessarily follow that there was no production in the
country.
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Self-Test
3. Identify and explain the three approaches to

computing GDP.
The three approaches are expenditure, income, and value added. In
the expenditure approach, we add the amount of money spent by
buyers on final goods and services. In the income approach, we
sum the payments to the resources of production. In our example in
the text, income consisted of the returns to labor (wages) and
entrepreneurship (profits).In the value-added approach, we sum the
dollar value contribution over all stages of production.
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GDP - Expenditure Approach
4 Sectors
Household Sector - Consumption

Business Sector - Investment
Government Sector – Government Purchases
Foreign Sector – Net Exports
GDP = C + I + G + (X – M)
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Consumption
The sum of household spending on:

Durable goods
Nondurable goods
Services
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Durable Goods
Durable goods are goods that are expected to last for

more than three years, such as refrigerators, ovens, or
cars.
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Nondurable Goods
Nondurable goods are goods that are not expected to last

for more than three years, such as food.
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Services
Services are intangible items such as lawn care, car

repair, and entertainment.
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Investment
The sum of all purchases of:

Fixed Investment -Newly produced capital
goods - Business purchases of capital
goods, such as machinery and factories
Inventory Investment -Changes in
business inventories (stock of unsold
goods).
Purchases of new residential housing
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Government Purchases
Includes:
Federal, state, and local government purchases of
goods and services and gross investment in
highways, bridges, and so on.
Excludes:
Government transfer payments to persons that are
not made in return for goods and services currently
supplied.
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Net Exports
Exports (X) - Total foreign spending on domestic (U.S.) goods

Less
Imports (M) - Total domestic (U.S.) spending on foreign goods
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Expenditure Approach
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GDP 2011
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Are all increases in GDP good for the
economy?
Recall that investment can rise for one of three reasons:
(1) Firms may purchase more newly produced capital goods
(firms buy more factories and machinery);
(2) individuals may purchase new residential housing
(someone buys a new home); or
(3) firms’ inventory investment rises.
Further, firms’ inventory investment can rise in two ways:
• Planned inventory investment. Firms may deliberately
produce more units of a good and add them to inventory.
• Unplanned inventory investment. Consumers don’t buy as
many units of output as firms have produced, and unsold units
are added to inventory.
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Bureau of Economic Analysis
BEA is an agency of the U.S. Department of Commerce.
One of its major functions is to assemble the data which is
then used to calculate GDP.
To get the latest information on GDP

and other economic data, click below
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Self-Test
1. Describe the expenditure approach to
computing GDP in a real-world economy.
In the expenditure approach, GDP is computed by finding the sum of
consumption, investment, government purchases, and net exports. (Net
exports are equal to exports minus imports.)
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Self-Test
2. Will GDP be smaller than the sum of

consumption, investment, and government
purchases if net exports are negative?
Explain your answer.
Yes. To illustrate, suppose consumption is $200, investment is $80,
and government purchases are $70. The sum of these three
spending components of GDP is $350. Now suppose exports are $0
but imports are $100, which means that net exports are $100. Since
GDP = C + I + G + (EX - IM),it follows that GDP is $250.
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Self-Test
3. If GDP is $400 billion and the country’s

population is 100 million, does it follow that
each individual in the country has $40,000
worth of goods and services?
No. Each individual would have $40,000 worth of goods and
services only if the entire GDP were equally distributed across the
country. There is no indication that this is the case. The $40,000
(per capita GDP) says that the “average” person in the country has
access to $40,000 worth of goods and services, but in reality, there
may not be any “average” person. For example, if Smith earns
$10,000 and Jones earns $20,000, then the average person earns
$15,000. But neither Smith nor Jones earns $15,000, so neither is
average.
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GDP – Income Approach
1. Purchases (expenditures) made in product markets flow to
business firms.
2. Business firms then use these monies to buy resources in
resource markets.
3. These monies flow to the owners (suppliers) of land, labor,
capital, and entrepreneurship.
4. The sum of these resource payments is total income, which
flows to households. In this simple economy total
purchases (expenditures) equal total income.
5. Because total purchases (expenditures) equal GDP and
total purchases equal total income, it follows that GDP
equals total income.
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National Income
 Total income earned by U.S. citizens and businesses, no
matter where they reside or are located.
 National income is the sum of the payments to resources
(land, labor, capital, and entrepreneurship).
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Computing National Income
National income =
Compensation of employees
+ Proprietors’ income
+ Corporate profits
+ Rental income
+Net interest
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COMPENSATION OF EMPLOYEES
Compensation of employees consists of wages and salaries
paid to employees plus employers’ contributions to Social
Security and employee benefit plans plus the monetary
value of fringe benefits, tips, and paid vacations.
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PROPRIETORS’ INCOME
Proprietors’ income includes all forms of income earned by
self-employed individuals and the owners of unincorporated
businesses, including unincorporated farmers.
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CORPORATE PROFITS
Corporate profits include all the income earned by the
stockholders of corporations.
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RENTAL INCOME (OF PERSONS)
 Rental income is the income received by individuals for

the use of their non-monetary assets (land, houses,
offices).
 It also includes returns to individuals who hold
copyrights and patents.
 Finally, it includes an imputed value to owner-occupied
houses.
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NET INTEREST
Net interest is the interest income received by U.S.
households and government minus the interest they paid
out.
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From NI to GDP
GDP =
National income
- Income earned from the rest of the world
+ Income earned by the rest of the world
+ Indirect business taxes
+ Capital consumption allowance
+ Statistical discrepancy
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GDP = Income Approach
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Net Domestic Product
NDP measures the total value of new goods
available in the economy in a given year after worn-
out capital goods have been replaced.
Net domestic product (NDP) =

GDP – Capital consumption allowance*
*The estimated amount of capital goods used up in

production through natural wear, obsolescence,
and accidental destruction.
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Personal and Disposable Income
Personal income =
National income
– Undistributed corporate profits
– Social insurance taxes
– Corporate profits taxes
+ Transfer payments
Disposable income =
Personal income
– Personal taxes
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Real GDP
The value of the entire output produced annually within a

country’s borders, adjusted for price changes (inflation).
Real GDP = Σ(Base-year prices X Current-year quantities)
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Economic Growth
Economic Growth is measured by increases in Real GDP.

𝑅𝑒𝑎𝑙 𝐺𝐷𝑃𝐿𝑎𝑡𝑒𝑟 𝑌𝑒𝑎𝑟 − 𝑅𝑒𝑎𝑙 𝐺𝐷𝑃 𝐸𝑎𝑟𝑙𝑖𝑒𝑟 𝑌𝑒𝑎𝑟
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒𝐶h𝑎𝑛𝑔𝑒 𝑖𝑛 𝑅𝑒𝑎𝑙𝐺𝐷𝑃=
(
𝑅𝑒𝑎𝑙 𝐺𝐷𝑃𝐸𝑎𝑟𝑙𝑖𝑒𝑟 𝑌𝑒𝑎𝑟
𝑋 100
)
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Business Cycle
Recurrent swings (up and down) in Real GDP.
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Business Cycle
1. Peak. At the peak of the business cycle, Real GDP is at a temporary

high. In the exhibit, Real GDP is at a temporary high at Q1.
2. Contraction. The contraction phase represents a decline in Real
GDP. According to the standard definition of recession, two
consecutive quarter declines in Real GDP constitute a recession.
3. Trough. The low point in Real GDP, just before it begins to turn up,
is called the trough of the business cycle.
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Business Cycle
4. Recovery. The recovery is the period when Real GDP is rising. It begins at the
trough and ends at the initial peak. The recovery in the exhibit extends from the
trough until Real GDP is again at Q1.
5. Expansion. The expansion phase refers to increases in Real GDP beyond the
recovery. In the exhibit, it refers to increases in Real GDP above Q.
An entire business cycle is measured from peak to peak. The typical business
cycle is approximately four to five years, although a few have been shorter and
some have been longer.
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Business Cycles and the NBER
For current economic data and business cycle

information visit the National Bureau of Economic
Research by clicking the logo below.
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NBER and Recessions
The standard definition of a recession is two

consecutive quarter declines in Real GDP, but this
is not the only definition of a recession.
The National Bureau of Economic Research has
this to say about a recession.
A recession is a period between a peak and a
trough . . . During a recession, a significant decline
in economic activity spreads across the economy
and can last from a few months to more than a
year.
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Self-Test
1. Suppose GDP is $6 trillion in year 1 and $6.2

trillion in year 2. What has caused the rise in
GDP?
We can’t know for sure; we can say what may have caused the
rise in GDP. It could be (a) a rise in prices, no change in output,
(b) a rise in output , no changes in prices, (c) rises in both prices
and outputs, (d) a percentage increase in prices that is greater
than a percentage decrease in output, or some other situation.
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Self-Test
2. Suppose Real GDP is $5.2 trillion in year 1 and
$5.3 trillion in year 2. What has caused the rise
in Real GDP?
More output was produced in year 2 than in year 1.
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Self-Test
3. Can an economy be faced with endless
business cycles and still have its Real GDP
grow over time? Explain your answer.
Yes. Business cycles – ups and downs in Real GDP – don’t prevent
Real GDP from growing over time.
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Other Sources of Economic Data
 White House - Economic

Statistics Briefing Room
 Congressional Budget Offi
ce
 Bureau of the Census
Click above to Select
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Wall Street Journal
The Wall Street Journal is a is a rich source of

information which provides real life examples of micro-
and macro economic activities. Check today’s issue to
see the most current news.
http://www.wsj.com
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© 2014 Cengage Learning. All Rights Reserved.

May not be copied, scanned,

Gross Domestic Product

Business Cycles above

The total market value of all

* Goods in the hands of their final users.

 Income Approach – add the sum of all incomes earned

Certain non-market goods and

 Financial transactions such as trading

 GDP counts the

Click above to view data from the CIA Fact

1. Why aren’t stock purchases and sales

2. Suppose the GDP for a country is $0. Does

3. Identify and explain the three approaches to

Household Sector - Consumption

The sum of household spending on:

Durable goods are goods that are expected to last for

Nondurable goods are goods that are not expected to last

Services are intangible items such as lawn care, car

The sum of all purchases of:

Exports (X) - Total foreign spending on domestic (U.S.) goods

To get the latest information on GDP

2. Will GDP be smaller than the sum of

3. If GDP is $400 billion and the country’s

 Rental income is the income received by individuals for

Net domestic product (NDP) =

*The estimated amount of capital goods used up in

The value of the entire output produced annually within a

Recurrent swings (up and down) in Real GDP.

1. Peak. At the peak of the business cycle, Real GDP is at a temporary

For current economic data and business cycle

The standard definition of a recession is two

1. Suppose GDP is $6 trillion in year 1 and $6.2

 White House - Economic

 Bureau of the Census

Click above to Select

The Wall Street Journal is a is a rich source of

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