Chapter 7

Macroeconomic Measurements, Part II GDP and Real GDP

 Gross Domestic Product
• GDP is the total market value of all final goods and services produced
annually within a country’s borders.
• GDP is a Flow Variable: A Flow Variable is a variable that is only meaningful
over a period of time. GDP is NOT a Stock Variable: A Stock Variable is a
variable that is meaningful at a moment in time. The money supply is a
stock variable.
• When we say GDP, we usually mean Nominal GDP, i.e. GDP valued at
average annual retail prices in the current year.

• GDP vs GNP: Gross National Product is the total market value of all final
goods and services provided annually by the citizens of a country. GDP
measures all final goods produced in a country, whether by citizens or not.
GNP measures all final goods produced by citizens whether in that
country or not.
Some useful definitions:
• Total Market Value is the monetary value of goods and services at
today’s prices.
• A final good is a good in the hands of the final user. Only final goods
are counted to protect against the error of over-counting
• An intermediate good is an input in the production of a final good.
if a good does not go for further processing, it is considered as final
good. For example, the machines, tools, office and factory buildings helps
us to produce goods and services, but those do not undergo any
processing. Therefore, they are final goods.
• We make distinction between intermediate and final goods in order to
avoid double counting problem. Double counting refers to counting a
good more than once when computing GDP. For example, adding the
value of all wheat grains and wheat flour and breads, cakes and
biscuits gives rise to multiple counting.
 Real GDP, per capita GDP
• To find out real GDP of a year we are required to multiply the quantities of
different final goods by the corresponding base year prices. We may also find
out Real GDP of a year by dividing the corresponding Nominal GDP by GDP
deflator of that year and then multiply the ratio by 100.

• Real GDP = (Nominal GDP/ GDP deflator) × 100

GDP deflator = (Nominal GDP / Real GDP) × 100

Where, O= base year, 1=current year, i=1,2…..,n ; number of goods

• Dividing the Real GDP by the size of the home country population we obtain
per capita Real GDP. Similar method is used to obtain per capita Nominal GDP.
 What GDP Omits
• Nonmarket Goods and Services
• Underground Activities (legal and illegal)
• Sale of Used Goods (recondition cars),
• Financial Transactions (trading of stocks and bonds are
these merely represent change of ownership- no value
is added),
• Prize from lottery games.
• Government Transfer Payments (social security
benefits),
• Leisure is not considered.
• Not adjusted for “bads” (explain the concept of Green
GDP)
 Important factor

GDP figures are useful for obtaining an estimate of the

productive capabilities of an economy, but they do not
necessarily measure happiness or well being. Therefore,
economists use HDI, MPI etc. indicators.
 Three Ways of Computing GDP
1. The Expenditure Approach:
There are four sectors in the economy – household sector, business sector,
government sector and the foreign sector. Expenditures of each sector
are called respectively - consumption, investment, government
purchases and net export.
• Consumption includes spending on durable goods, spending on non-
durable goods, and spending on services in the home country.
• Investment is the sum of purchases of newly produced capital goods,
changes in business inventories, and purchase of new residential
housing in the home country.
• Government purchases include federal, state, and local government
purchases of goods and services and gross investment in highways,
bridges, and so on.
• Net Exports is the total export of domestic goods to foreigners minus
total import of foreign goods that are used by households, business
firms, and government.
Computing GDP using the Expenditure Approach

The expenditure approach sums the purchases of final goods

and services made by the four sectors of the economy.
GDP = Consumption + Investment + Government Purchases +
Net Exports

(Conflict with the definition of GDP? Anything that is not

sold is “bought” by the firm that produces it.)
 2. The Income Approach to Measuring GDP

• Domestic Income is the total income earned by the

people and businesses within a country’s borders.

• National Income is the total income earned by the

citizens and businesses, no matter where they are
located.
 Income Approach to GNP
• Components of National Income:
 Compensation of Employees: Wages, salaries, Social Security benefits,
and employee benefit plans plus the monetary value of fringe benefits,
tips, and paid vacations.
 Proprietors’ Income is all forms of income earned by self-employed
individuals and the owners of unincorporated business, including
unincorporated farmers.
 Corporate Profits include all income earned by the stockholders of
corporations.
 Rental Income of Persons is the income received by individuals for the use
of their non-monetary assets.
 Net interest: Interest income received by households and government
minus the interest they paid out.
 National Income 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

• the National income excludes foreign nationals and includes citizens abroad,
but the GDP has to adjust for both of these incomes.
• Indirect Business Taxes usually comprise excise taxes, sales taxes, and
property taxes.
• Capital Consumption Allowance or depreciation is the cost to replace capital
goods that break or wear down
• Statistical discrepancies or pure computational errors often occur
 3. Value Added Approach
• Value added is the dollar value contributed to a final good at each stage
of production.
To compute GDP using the value-added approach we try to find out the
sum of the value added at all the stages of production.

Value added = Total Revenue – Cost of intermediate goods.

Other National Income Accounting Measurements:
• Net Domestic Product = GDP – Capital consumption allowance
• Personal Income is the amount of income that individuals actually
receives. So,
Personal Income = National income – Undistributed Corporate Profits –
Social Security Taxes – Corporate Profit Taxes + Transfer Payments
• Disposable Income is the proportion of income that can be used for
consumption or savings. So,
Disposable Income = Personal Income – Personal Taxes
Real GDP:
• Real GDP is GDP adjusted for price changes.
• Real GDP= ∑(Base year prices × Current year quantities)
• Real GDP rises only if more goods and services are produced.

Economic Growth: Annual economic growth has occurred if the Real GDP in
one year is higher than the previous year.

Percentage change in real GDP =

[(Real GDP later year – Real GDP earlier year )/ Real GDP earlier year ] × 100
 Ups and downs of the Business Cycle
• Peak: at the peak of the business cycle, Real GDP is at a temporary high.
• Contraction: A decline in the real GDP. If it falls for two consecutive
quarters, it is said to be in a recession.
• Trough: The Low Point of the GDP, just before it begins to turn up.
• Recovery: When the GDP is rising from the trough.
• Expansion: when the real GDP expands beyond the recovery

An entire business cycle is measured from peak to peak.

The Business Cycle