Chapter 7

GDP: Measuring Total Production and Income

Macroeconomics The study of the economy as a whole, including topics such as inflation,
unemployment, and economic growth.

Business cycle Alternating periods of economic expansion and economic recession.

Expansion The period of a business cycle during which total production and total
employment are increasing.

Recession The period of a business cycle during which total production and total
employment are decreasing.

Economic growth The ability of an economy to produce increasing quantities of goods and
services.

Inflation rate The percentage increase in the price level from one year to the next.

Transfer payments Payments by the government to individuals for which the government
does not receive a good or service in return.
 Annual Changes in U.S. Economic Output
(Real GDP - Chainweighted 2000$)

5%
4.4%
4.3% 4.2%
4.0% 4.1%
4% 3.8% 3.8%
3.6% 3.6%
3.5%
3.4%
3.1% 3.1%
2.9%
3% 2.7% 2.7% 2.7%

2% 1.8%
1.6%

1%
0.3%

0%

-0.5%

-1%
86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Source: Department of Commerce.

Domestic Production, Y =100

Foreign Production, M=17

Inventory Sales, C + I + G + X
70 + 17 +19 +11
 Equilibrium Condition
Q.S. = Q.D.

Y+M=C+I+G+X

2006 $ Trillion

$13.2 + $2.2 = $9.2 + $2.2 + $2.5 + $1.5

Divide by Y (13.2 trillion) to get relative perspective

100% + 17% = 70% + 17% + 19% + 11%

For heuristic reasons, multiply by 100

100 + 17 = 70 + 17 + 19 + 11
Or
100 = 70 + 17 + 19 + 11 – 17

Y=C+I+G+X-M
 Measuring Total Production: Gross Domestic Product
Gross domestic product (GDP) The market value of all
final goods and services produced in a country during a
period of time.
• GDP IS MEASURED USING MARKET VALUES, NOT
QUANTITIES

• GDP INCLUDES ONLY THE MARKET VALUE OF FINAL

GOODS
Final good or service A good or service purchased by a final user.
Intermediate good or service A good or service that is an input into
another good or service, such as a tire on a truck.

• GDP INCLUDES ONLY CURRENT PRODUCTION

 The Circular Flow Diagram
$13.2 Trillion $1.5

$2.2 $2.2
$2.5

$9.2-2.2= $7

$0.7
 Components of GDP
PERSONAL CONSUMPTION EXPENDITURES, OR “CONSUMPTION”
Consumption Spending by households on goods and services, not including
spending on new houses.

GROSS PRIVATE DOMESTIC INVESTMENT, OR “INVESTMENT”

Investment Spending by firms on new factories, office buildings,
machinery, and inventories, and spending by households on new houses.

GOVERNMENT CONSUMPTION AND GROSS INVESTMENT, OR

“GOVERNMENT PURCHASES”
Government purchases Spending by federal, state, and local governments
on goods and services.

NET EXPORTS OF GOODS AND SERVICES, OR “NET EXPORTS”

Net exports Exports minus imports.
An Equation for GDP and Some Actual Values

Y = C + I + G + NX
Two Ways of Measuring GDP:
The two methods of calculating GDP are summarized below:

Expenditure Approach Resource Cost-Income Approach

Personal consumption expenditures Aggregate income:
+ Employee Compensation
Gross private domestic investment Income of self-employed
Rents
+ Profits
Government consumption Interest
and gross investment +
+ Non-income cost items:
Net exports of goods and services Indirect business taxes
and depreciation
= GDP +
Net income of foreigners
= GDP
The Expenditure Method of Measuring GDP

Expenditure Approach:
GDP is the sum of expenditures on final-user goods and services
purchased by households, investors, governments, and
foreigners.

There are four components of GDP:

• personal consumption purchases
• gross private investment
(including inventories)
• government purchases
(consumption and investment)
• net exports (exports minus imports)
Resource Cost-Income Method of Measuring GDP
Resource Cost - Income Approach
GDP is the sum of costs incurred and income (including profits) generated by the
production of goods and services during the period.

The direct cost income components of GDP:

employee compensation
self-employment income
rents
interest
corporate profits
Sum of these = national income

Not all cost components of GDP result in an income payment to a resource supplier.
To get GDP, we need to account for 3 other factors:
Indirect business taxes:
Taxes that increase the firm’s production costs and therefore final prices.
Depreciation:
The cost of wear and tear on the machines and other capital assets used to produce
goods and services.
Net Income of Foreigners:
The income that foreigners earn producing goods within the borders of the U.S.
minus the income Americans earn abroad.
Relative Size of U.S. GDP Components: 2000-2003

(a) Expenditure approach (b) Resource cost-income approach a

Private Net exports Rental income
investment Indirect Net
- 4% taxes interest 1%

5%
16%
Depreciation 8%
Gov’t
12%
18% 58%
Corporate
profits 8%

70% 7% Employee
Self-employed
Personal proprietor income compensation
consumption
Source: http://www.economagic.com. a The net income of foreigners was negligible.
 Calculating GDP

PRODUCTION AND PRICE STATISTICS FOR 2007

(1) (2) (3)
PRODUCT QUANTITY PRICE PER UNIT
Eye examinations 100 $50.00
Pizzas 80 10.00
Textbooks 20 100.00
Paper 2,000 0.10

(1) (2) (3)

PRODUCT QUANTITY PRICE PER UNIT VALUE
Eye examinations 100 $50 $5,000
Pizzas 80 10 800
Textbooks 20 100 2,000
 Measuring GDP by the Value Added Method

Value added The market value a firm adds to a product.

FIRM VALUE OF PRODUCT VALUE ADDED

Cotton Farmer Value of raw cotton = $1.00 Value added by cotton farmer = $1.00
Textile Mill Value of raw cotton woven into cotton Value added by cotton textile mill =
fabric = $3.00 ($3.00 – $1.00) = $2.00
Shirt Company Value of cotton fabric made into a Value added by shirt manufacturer =
shirt = $15.00 ($15.00 –$3.00) = $12.00
L.L. Bean Value of shirt for sale on L.L. Bean’s Value added by L.L. Bean = ($35.00
Web site = $35.00 – $15.00) = $20.00
Total Value Added = $35.00
 Real GDP versus Nominal GDP
Calculating Real GDP
Real GDP The value of final goods and services evaluated at base year
prices.

Nominal GDP The value of final goods and services evaluated at current
year prices.

The GDP Deflator

Price level A measure of the average prices of goods and services in the
economy.

GDP deflator A measure of the price level, calculated by dividing

nominal GDP by real GDP, and multiplying by 100.

Nominal GDP
GDP deflator = x 100
Real GDP
 Calculating Real GDP

2000 2005

PRODUCT QUANTITY PRICE QUANTITY PRICE

Eye examinations 80 $40 100 $50

Pizzas 90 $11 80 $10

Textbooks 15 $90 20 $100

PRODUCT QUANTITY PRICE VALUE

Eye examinations 100 $40 $4,000

Pizzas 80 $11 $880

Textbooks 20 $90 $1,800

Other Measures of Total Production and Total Income

Gross Domestic Product (GDP) $13.197 Trillion

+ Foreign production of domestic firms $0.661 Trillion
- Domestic production of foreign firms $0.638 Trillion
Gross National Product (GNP) $13.220 Trillion
- Consumption of fixed capital (depreciation) $1.573 Trillion
Net National Product (NNP) $11.647 Trillion
- Indirect business taxes (sales tax) $.914 Trillion
National Income $10.733 Trillion
- Retained earnings $0.963 Trillion
+ Transfer payments & government bond interest $1.131 Trillion
Personal Income $10.901 Trillion
- Personal tax payments (federal personal income tax) $1.378 Trillion
Disposable Personal Income $9,522 Trillion
- Personal outlays $9.577 Trillion
Personal Savings $-0.054 Trillion
 Homework 7
Due Friday March 2

Problems and Applications,…. pages 225-226

Problems 6,7,8,13,20