MACROECONOMICS

Department of Economics
Faculty of Business Administration
Chapter 23
MEASURING A
NATION’S INCOME
N . G r e g o r y M a n k i w, P r i n c i p l e s o f
Economics, 9th Edition, Cengage
Learning, 2021
Chapter 23
At the end of this chapter, students are able to:
• Understand Gross Domestic Product (GDP) and how to
measure it.
• Explain how is GDP related to a nation’s total income and
spending.
• List and describe components contributed to GDP.
• Define nominal GDP and real GDP and learn to correct
them for inflation.
• Explain why GDP is a good method to evaluate the
economics well-being.

3
 OUTLINE
1. The Economy’s Income and Expenditure

2. The Measurement of GDP

3. The Components of GDP

4. Real versus Nominal GDP

5. Is GDP a Good Measure of Economic Well-Being?

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 4

 Economics

• Microeconomics
• Study of how households and firms
• Make decisions
• Interact in markets
• Macroeconomics
• Study of economy-wide phenomena
• Including inflation, unemployment, and
economic growth

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 5

 Income and Expenditure

• Gross Domestic Product (GDP)

• Measures total income of everyone in the economy.
• Also measures total expenditure on the economy’s output of
goods and services.
• Income equals expenditure
• For the economy as a whole
• Because every dollar a buyer spends is a dollar of income for
the seller.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 6

 The Circular-Flow Diagram

The Circular-Flow Diagram

• Simple depiction of the macroeconomy
• Illustrates GDP as spending, revenue,
factor payments, and income
Preliminaries:
• Factors of production are inputs like labor, land, capital, and natural
resources.
• Factor payments are payments to the factors of production (e.g.,
wages, rent).

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 7

 The Circular-Flow Diagram

Households:
• Own the factors of production, sell/rent them to firms for income
• Buy and consume goods & services

Firms
• Buy/hire factors of production, use them to produce goods and
services
• Sell goods & services

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 8

 The Circular-Flow Diagram
Revenue (=GDP) Spending (=GDP)
Markets for
G&S Goods &
G&S
sold Services bought

Firms Households

Factors of Labor, land,

production Markets for capital
Factors of
Wages, rent, Production Income (=GDP)
profit (=GDP)
Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021
 What This Diagram Omits
The government
• Collects taxes, buys goods and services
The financial system
• Matches savers’ supply of funds with
borrowers’ demand for loans
The foreign sector
• Trades goods and services, financial assets, and currencies with
the country’s residents

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 10

Gross Domestic Product (GDP) is…
…the market value of all final goods & services produced
within a country
in a given period of time.

Goods are valued at their market prices, so:

• All goods measured in the same units
(e.g., dollars in the U.S.)
• Things that don’t have a market value are excluded, e.g., housework
you do for yourself.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 11

Gross Domestic Product (GDP) is…

…the market value of all final goods & services produced

within a country
in a given period of time.

• GDP includes all items produced in the economy and sold legally in
markets
• GDP excludes most items produced and sold illicitly. It also excludes
most items that are produced and consumed at home.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 12

Gross Domestic Product (GDP) is…

…the market value of all final goods & services produced

within a country
in a given period of time.
• Final goods: intended for the end user
• Intermediate goods: used as components
or ingredients in the production of other goods
• GDP only includes final goods—they already embody the value of the
intermediate goods
used in their production.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 13

Gross Domestic Product (GDP) is…

…the market value of all final goods & services produced

within a country
in a given period of time.

• GDP includes tangible goods

(like DVDs, mountain bikes, beer)
• and intangible services
(dry cleaning, concerts, cell phone service).

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 14

Gross Domestic Product (GDP) is…

…the market value of all final goods & services produced

within a country
in a given period of time.

• GDP includes currently produced goods, not goods produced in the past.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 15

Gross Domestic Product (GDP) is…

…the market value of all final goods & services produced

within a country
in a given period of time.

• GDP measures the value of production that occurs within a country’s

borders, whether done by its own citizens or by foreigners located
there.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 16

Gross Domestic Product (GDP) is…
…the market value of all final goods & services produced
within a country
in a given period of time.

• Usually a year or a quarter (3 months)

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 17

 The Components of GDP
Recall: GDP is total spending.
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

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 18

 Consumption (C)

Consumption, C
• Total spending by households on goods and
services
Note on housing costs:
• For renters, C includes rent payments.
• For homeowners, C includes the imputed
rental value of the house, but not the
purchase price or mortgage payments
• Not included in C: purchases of new housing

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 19

 Investment (I)
Investment, I
• Total spending on goods that will be used in the future to
produce more goods
• Business capital: business structures, equipment, and
intellectual property products
• Residential capital: landlord’s apartment building; a
homeowner’s personal residence
• Inventory accumulations: goods produced but not yet sold
“Investment” does not mean the purchase of financial assets like
stocks and bonds.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 20

 Government Purchases (G)

Government purchases (G)

• All spending on the goods and services purchased by the
government
• At the federal, state, and local levels.
• Excludes transfer payments
• Such as Social Security or unemployment insurance benefits.
• They are not purchases of goods and services

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 21

 Net Exports (NX)
Net exports, NX = exports – imports
• Exports: foreign spending on the economy’s goods and services
• Imports: are the portions of C, I, and G
that are spent on goods and services produced abroad
Adding up all the components of GDP gives:
Y = C + I + G + NX

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 22

U.S. GDP and Its Components, 2015

Billions % of GDP Per capita

Y $17,947 100.0 $55,426
C 12,272 68.4 37,899
I 3,021 16.8 9,330
G 3,183 17.7 9,830
NX -529 -2.9 -1,634
23
 Active Learning 1
GDP and its components
In each of the following cases, determine how much GDP and each of its
components is affected (if at all).
A. Debbie spends $300 to buy her husband dinner at the finest restaurant in
Boston. Consumption 300$ GDB increase 300$
B. Sarah spends $1200 on a new laptop to use in her publishing business.
The laptop was built in China. Investment - nx = 1200$-1200$ (GDB
unchanged)
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.
Investment because of last year so I not change=> GDB unchange
D. General Motors builds $500 million worth of cars, but consumers only buy
$470of Economics,
Mankiw, N. G., Principles million worth
9th Edition, Cengage of them.
Learning, 2021 I raise 470m$ inventory investment raise 24
Real versus Nominal GDP
Nominal GDP
• Values output using current prices
• Not corrected for inflation
Real GDP
• Values output using the prices of a base year
• Is corrected for inflation
For the base year
• Nominal GDP = Real GDP

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 25

 Example 1

Compute nominal GDP in each year:

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

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 26

 Example 2

Compute real GDP in each year, using 2014 as the base year:

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

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 27

Nominal and Real GDP in the U.S., 1965–2015

Real GDP
(base year
2009)

Nominal
GDP
 The GDP Deflator

GDP deflator
• A measure of the overall level of prices.

• Measures the current level of prices relative to

the level of prices in the base year
Economy’s inflation rate
• Compute the percentage increase in the GDP
deflator from one year to the next

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 29

 Example 3
Compute the GDP deflator in each year:
Nominal Real GDP
year GDP GDP Deflator
2014 $6000 $6000
2015 $8250 $7200
2016 $10,800 $8400

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 30

 Active Learning 2
Computing GDP
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

Use the above data to solve these problems:

A. Compute nominal GDP in 2014.
B. Compute real GDP in 2015.
C. Compute the GDP deflator in 2016.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 31

 GDP and Economic Well-Being

Real GDP per capita

• Main indicator of the average person’s standard of living
But GDP is not a perfect measure of well-being.
• Robert Kennedy issued a very eloquent yet harsh criticism of
GDP:

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 32

 Senator Robert Kennedy, 1968
Gross Domestic Product…
“… does not allow for the health of our children, the quality of their
education, or the joy of their play.
It does not include the beauty of our poetry or the strength of our
marriages, the intelligence of our public debate or the integrity of
our public officials.
It measures neither our courage, nor our wisdom, nor our devotion
to our country.
It measures everything, in short, except that which makes life
worthwhile, and it can tell us everything about America except why
we are proud that we are Americans.”

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 33

 GDP Does Not Value:

• The quality of the environment

• Leisure time
• Non-market activity, such as the child care
a parent provides at home
• An equitable distribution of income

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 34

Then Why Do We Care About GDP?

Having a large GDP enables a country to afford

• Better schools, a cleaner environment, health care, etc.
Many indicators of the quality of life are positively correlated
with GDP. For example…

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 35

GDP and Life Expectancy in 12 countries
GDP and Average Schooling in 12 countries
GDP and Overall Life Satisfaction (0 to 10 scale) in 12
countries
 VIDEO

39
Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021
 CONCLUSION

• We learned how economists measure the total income of a nation.

• The significance of measuring GDP is the first step to acknowledge
some senses of how the economy is doing and developing a science
of macroeconomics

40
Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021
 • Gross Domestic Product (GDP) measures a country’s total income
and expenditure.
• The four spending components of GDP include: Consumption,
Investment, Government Purchases, and Net Exports.
• Nominal GDP is measured using current prices.
• Real GDP is measured using the prices of a constant base year and
is corrected for inflation.
• GDP is the main indicator of a country’s economic well-being, even
though it is not perfect.
Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 41
 • Gross Domestic Product – GDP: The market value of all final goods and services
produced within a country in a given period of time
• Consumption: Spending by households on goods and services, with the exception
of purchases of new housing
• Investment: Spending on business capital, residential capital, and inventories
• Government purchase: Spending on goods and services by local, state, and federal
governments
• Net Exports: spending on domestically produced goods by foreigners (exports)
minus spending on foreign goods by domestic residents (imports)
• Nominal GDP: The production of goods and services valued at current prices
• Real GDP: The production of goods and services valued at constant prices
• GDP deflator: a measure of the price level calculated as the ratio of nominal GDP to
real GDP times 100
Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 42
 QUESTION FOR REVIEW
1. Explain why an economy’s income must equal its expenditure.
2. Which contributes more to GDP—the production of an economy car or the
production of a luxury car? Why?
3. A farmer sells wheat to a baker for $2. The baker uses the wheat to make bread,
which is sold for $3. What is the total contribution of these transactions to GDP?
4. Many years ago, Sophie paid $500 to put together a record collection. Today, she sold
her albums at a garage sale for $100. How does this sale affect current GDP?
5. List the four components of GDP. Give an example of each.
6. Why do economists use real GDP rather than nominal GDP to gauge economic well-
being?
7. In the year 2020, the economy produces 100 loaves of bread that sell for $2 each. In
the year 2021, the economy produces 200 loaves of bread that sell for $3 each.
Calculate nominal GDP, real GDP, and the GDP deflator for each year. (Use 2020 as the
base year.) By what percentage does each of these three statistics rise from one year to
the next? 43
Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021
 QUICK QUIZ
1. An economy’s gross domestic product is:
a. The excess of spending over income.
b. The excess of income over spending.
c. Total income and total spending.
d. Total income times total spending.
2. Sam bakes a cake and sells it to Carla for $10. Woody pays Diane
$30 to tutor him. In this economy, GDP is:
a. $10 b. $20 c. $30 d. $40

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 44

 QUICK QUIZ
3. If the price of a hot dog is $2 and the price of a hamburger is $4,
then 30 hot dogs contribute as much to GDP as _________
hamburgers.
a. 5 b. 15 c. 30 d. 60

4. Angus the sheep farmer sells wool to Barnaby the knitter for $20.
Barnaby makes two sweaters, each of which has a market price of $40.
Collette buys one of them, while the other remains on the shelf of
Barnaby’s store to be sold later. What is GDP here?
a. $40 b. $60 c. $80 d. $100
Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 45
 QUICK QUIZ

5. After graduation, an American college student moves to Japan

to teach English. Her salary is included:
a. Only in U.S. GDP
b. Only in Japan’s GDP
c. In both U.S. GDP and Japan’s GDP
d. In neither U.S. GDP nor Japan’s GDP

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 46

 QUICK QUIZ

6. Which of the following does NOT add to U.S. GDP?

a. Boeing manufactures and sells a plane to Air France.
b. General Motors builds a new auto factory in North Carolina.
c. The city of New York pays a salary to a policeman.
d. The federal government sends a Social Security check to your
grandmother.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 47

 QUICK QUIZ

7. An American buys a pair of shoes made in Italy. How do the U.S.

national income accounts treat the transaction?
a. Net exports and GDP both rise.
b. Net exports and GDP both fall.
c. Net exports fall, while GDP does not change.
d. Net exports do not change, while GDP rises.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 48

 QUICK QUIZ

8. Which is the largest component of GDP?

a. Consumption b. Investment
c. Government purchases d. Net exports

9. An economy produces 10 cookies in year 1 at a price of $2 per cookie

and 12 cookies in year 2 at a price of $3 per cookie. From year 1 to year
2, real GDP increases by:
a. 20 percent. b. 50 percent.
c. 70 percent. d. 80 percent.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 49

 QUICK QUIZ

10. If all quantities produced rise by 5 percent and all prices fall
by 5 percent, which of the following best describes what occurs?
a. Real GDP rises by 5 percent, while nominal GDP falls by 5
percent.
b. Real GDP rises by 5 percent, while nominal GDP is unchanged.
c. Real GDP is unchanged, while nominal GDP rises by 5 percent.
d. Real GDP is unchanged, while nominal GDP falls by 5 percent.

Mankiw, N. G., Principles of Economics, 9th Edition, Cengage Learning, 2021 50

 QUICK QUIZ
11. If Mr. Keating quits his job as a teacher to home school his own children,
GDP:
a. Stays the same because he is engaged in the same activity.
b. Rises because he now pays lower income taxes.
c. Falls because his market income decreases.
d. Could rise or fall, depending on the value of home schooling.
12. GDP is an imperfect measure of well-being because it:
a. Includes physical goods produced but not intangible services.
b. Excludes goods and services provided by the government.
c. Ignores the environmental degradation from economic activity.
d. Is not correlated with other measures of the quality of life. 51
Thank You