ECON6098

Business Economics
Week 6

The Macroeconomic Environment

 Outline

 The Economy’s Income And Expenditure

 Gross Domestic Product (GDP) And Gross National
Product (GNP)
 The Components Of GDP
 Real Versus Nominal GDP
 Measuring the cost of living
THE ECONOMY’S INCOME AND
EXPENDITURE
The Circular-Flow Diagram
GROSS DOMESTIC PRODUCT (GDP)
AND GROSS NATIONAL PRODUCT
(GNP)
 GDP and GNP

 Gross Domestic Product (GDP) the market value of all

final goods and services produced within a country in a
given period of time
 Gross National Product (GNP) is the value of all final
goods and services made by a country's residents and
businesses, regardless of production location in a given
period of time
 Other Measures of Income

 NNP = GNP – depreciation

 NI = NNP – indirect taxes + business subsidies
 PI= NI – Social Security Contribution Tax – Corporate
Income tax – Retained Earnings + Transfer Payments
 DI= PI – Personal Taxes
DI=C+S
THE COMPONENTS OF GDP
 The Components of GDP

 Four components:
– Consumption (C)
– Investment (I)
– Government Purchases (G)
– Net Exports (NX)
 These components add up to GDP (denoted Y):

Y = C + I + G + NX
 Consumption (C)

 is total spending by households on g&s.

 Note on housing costs:
– For renters,
consumption includes rent payments.
– For homeowners,
consumption includes the imputed rental value of the
house, but not the purchase price or mortgage payments.
 Investment (I)

 is total spending on goods that will be used in the future to

produce more goods.
 includes spending on
– capital equipment (e.g., machines, tools)
– structures (factories, office buildings, houses)
– inventories (goods produced but not yet sold)
 Government Purchases
(G)
 is all spending on the g&s purchased by govt at the federal,
state, and local levels.
 G excludes transfer payments, such as
Social Security or unemployment insurance benefits.
They are not purchases of g&s.
 Net Exports (NX)

 NX = exports – imports
 Exports represent foreign spending on the economy’s g&s.
 Imports are the portions of C, I, and G
that are spent on g&s produced abroad.
 Adding up all the components of GDP gives:

Y = C + I + G + NX
REAL VERSUS NOMINAL GDP
 Real vs. Nominal GDP

 Nominal GDP is the value of final output produced in a given

period, measured in the prices of that period.
 Real GDP is the value of final output produced in a given
period, adjusted for changing prices.

 The general formula for computing real GDP is:

nominal GD P in year t
Real GDP in y ear t =
price index
 The GDP Deflator

 The GDP deflator is a measure of the price level calculated as

the ratio of nominal GDP to real GDP times 100.
 It tells us what portion of the rise in nominal GDP that is
attributable to a rise in prices rather than a rise in the
quantities produced.
 The GDP deflator is calculated as follows:
Nominal GDP
GDP Deflator   100
Real GDP
MEASURING THE COST OF LIVING
 The Consumer Price Index

 Consumer price index (CPI)

– Measure of the overall cost of goods & services
– Bought by a typical consumer

 The consumer price index is calculated :

1. Fix the basket
2. Find the prices
3. Compute the basket’s cost
4. Choose a base year and compute the index
5. Compute the inflation rate
 Problems in measuring the
cost of living

Substitution bias
Introduction of new goods
Unmeasured quality change
Calculating the CPI and the
inflation rate: an example
 The GDP deflator vs. consumer
price index

 GDP deflator
– Ratio of nominal GDP to real GDP
– Reflects prices of all goods & services produced
domestically
 CPI
– Reflects prices of goods & services bought by consumers
 References

 N. Gregory Mankiw, (2018), Principles Of Economics,

Eighth Edition, Cengage Learning, ISBN 13: 978-1-305-
58512-6, chapter 23,24
 N. Gregory Mankiw, Mark P. Taylor, Andrew Ashwin,
(2013). Business Economics, 1 Edition, Cengage Learning.
United Kingdom, ISBN: 978-1-4080-6981-3, Chapter 16
Thank You