PART II Concepts and Problems in Macroeconomics

CASE FAIR OSTER

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Measuring National Output and National Income

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CHAPTER OUTLINE Gross Domestic Product
Final Goods and Services Exclusion of Used Goods and Paper Transactions Exclusion of Output Produced Abroad by Domestically Owned Factors of Production

Calculating GDP
PART IV Concepts and Problems in Macroeconomics

The Expenditure Approach The Income Approach

Nominal versus Real GDP

Calculating Real GDP Calculating the GDP Deflator The Problems of Fixed Weights

Limitations of the GDP Concept

GDP and Social Welfare The Underground Economy Gross National Income per Capita

Looking Ahead
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PART IV Concepts and Problems in Macroeconomics

Gross Domestic Product: The total market value of all final goods and services produced within a given period by factors of production located within a country. Final goods and services: Goods and services produced for final use. Intermediate goods: Goods that are produced by one firm for use in further processing by another firm.

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Value added: The difference between the value of goods as they leave a stage of production and the cost of the goods as they entered that stage.
In calculating GDP, we can sum up the value added at each stage of production or we can take the value of final sales. We do not use the value of total sales in an economy to measure how much output has been produced.
PART IV Concepts and Problems in Macroeconomics

TABLE 21.1 Value Added in the Production of a Gallon of Gasoline (Hypothetical Numbers) Stage of Production Value of Sales Value Added

(1)
(2) (3) (4)

Oil drilling
Refining Shipping Retail sale

$3.00
3.30 3.60 4.00

$3.00
0.30 0.30 0.40 $4.00

Total value added

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GDP is concerned only with new, or current, production. Old output is not counted in current GDP because it was already counted when it was produced.
GDP does not count transactions in which money or goods changes hands but in which no new goods and services are produced.

PART IV Concepts and Problems in Macroeconomics

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GDP is the value of output produced by factors of production located within a country.
Gross national product (GNP) The total market value of all final goods and services produced within a given period by factors of production owned by a countrys citizens, regardless of where the output is produced.

PART IV Concepts and Problems in Macroeconomics

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Calculating GDP
Using Expenditure approach: A method of computing GDP that measures the total amount spent on all final goods and services during a given period.
PART IV Concepts and Problems in Macroeconomics

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There are four main categories of expenditure: Personal consumption expenditures (C): household spending on consumer goods Gross private domestic investment (I): spending by firms and households on new capital, that is, plant, equipment, inventory, and new residential structures
PART IV Concepts and Problems in Macroeconomics

Government consumption and gross investment (G) Net exports (EX IM): net spending by the rest of the world, or exports (EX) minus imports (IM)

GDP = C + I + G + (EX IM)

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Personal Consumption Expenditures (C)

Expenditures by consumers on goods and services. It consists of: a) Durable goods Goods that last a relatively long time, such as cars and household appliances.
PART IV Concepts and Problems in Macroeconomics

b) Nondurable goods Goods that are used up fairly quickly, such as food and clothing. c) Services The things we buy that do not involve the production of physical things, such as legal and medical services and education.

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PART IV Concepts and Problems in Macroeconomics

Gross Private Domestic Investment (I) It is total investment in capitalthat is, the purchase of new housing, plants, equipment, and inventory by the private (or nongovernment) sector. a) Nonresidential investment Expenditures by firms for machines, tools, plants, and so on.
b) Residential investment Expenditures by households and firms on new houses and apartment buildings.

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c) Change in business inventories The amount by which firms inventories change during a period. Inventories are the goods that firms produce now but intend to sell later.

PART IV Concepts and Problems in Macroeconomics

GDP = Final sales + Change in business inventories

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Gross Investment versus Net Investment Depreciation: The amount by which an assets value falls in a given period. Gross investment The total value of all newly produced capital goods (plant, equipment, housing, and inventory) produced in a given period.
Net investment Gross investment minus depreciation.
Capitalend of period = Capitalbeginning of period + Net investment
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PART IV Concepts and Problems in Macroeconomics

Government Consumption and Gross Investment (G): Expenditures by federal, state, and local governments for final goods and services. Net Exports (EX IM) Net exports (EX IM) The difference between exports (sales to foreigners of U.S.-produced goods and services) and imports (U.S. purchases of goods and services from abroad). The figure can be positive or negative.

PART IV Concepts and Problems in Macroeconomics

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Disposable personal income or after-tax income Personal income minus personal income taxes. The amount that households have to spend or save.
Personal saving The amount of disposable income that is left after total personal spending in a given period. Personal saving rate The percentage of disposable personal income that is saved. If the personal saving rate is low, households are spending a large amount relative to their incomes; if it is high, households are spending cautiously.

PART IV Concepts and Problems in Macroeconomics

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Nominal versus Real GDP

Current dollars The current prices that we pay for goods and services. Nominal GDP Gross domestic product measured in current dollars.

PART IV Concepts and Problems in Macroeconomics

base year The year chosen for the weights in a fixed-weight procedure. The GDP deflator is one measure of the overall price level.

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Nominal versus Real GDP

Calculating Real GDP

TABLE 21.6 A Three-Good Economy

(1) (2) (3) (4) (5) GDP in Year 1 in Year 1 Prices P1 x Q1 (6) GDP in Year 2 in Year 1 Prices P1 x Q2 (7) GDP in Year 1 in Year 2 Prices P2 x Q1 (8) GDP in Year 2 in Year 2 Prices P2 X Q2

PART IV Concepts and Problems in Macroeconomics

Production Year 1 Year 2 Q1 Q2

Price Per Unit Year 1 Year 2 P1 P2

Good A Good B Good C Total

6 7 10

11 4 12

$0.50 0.30 0.70

$0.40 1.00 0.90

$3.00 2.10 7.00 $12.10 Nominal GDP in year 1

$5.50 1.20 8.40 $15.10

$2.40 7.00 9.00 $18.40

$4.40 4.00 10.80 $19.20 Nominal GDP in year 2

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Limitations of the GDP Concept

GDP and Social Welfare

An increase in leisure is also an increase in social welfare, sometimes associated with a decrease in GDP. Most nonmarket and domestic activities, such as housework and child care, are not counted in GDP even though they amount to real production.
PART IV Concepts and Problems in Macroeconomics

GDP also has nothing to say about the distribution of output among individuals in a society.

underground economy The part of the economy in which transactions take place and in which income is generated that is unreported and therefore not counted in GDP.

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PART IV Concepts and Problems in Macroeconomics

Consumer price index (CPI) is computed using a bundle of goods that represents the market basket purchased by the typical consumer. The CPI market basket shows how a typical consumer divides his or her money among various goods and services. Most of a consumers money goes toward housing, transportation, and food and beverages. Inflation May Change the Distribution of Income. Inflation may reduce the real interest rate. The real interest rate is the difference between the interest rate on a loan and the inflation rate.

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Labor force: The number of people employed plus the number of unemployed. Not in the labor force: A person who is not looking for work because he or she does not want a job or has given up looking

PART IV Concepts and Problems in Macroeconomics

unemployed unemployment rate = employed + unemployed

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fiscal policy The governments spending and taxing policies. monetary policy The behavior of the Federal Reserve concerning the nations money supply.

Government in the Economy

Government Purchases (G), Net Taxes (T), and Disposable Income (Yd).
PART IV Concepts and Problems in Macroeconomics

The disposable income (Yd) of households must end up as either consumption (C) or saving (S). Thus,

Yd = C + S
Because disposable income is aggregate income (Y) minus net taxes (T), we can write another identity: YT=C+S Or Y =C+S+T

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Planned aggregate expenditure (AE) is the sum of consumption spending by households (C), planned investment by business firms (I), and government purchases of goods and services (G).

AE + C + I + G budget deficit G T
PART IV Concepts and Problems in Macroeconomics

Firms and governments borrow funds by issuing bonds, and they pay interest to the lenders that purchase the bonds.
When interest rates rise, the prices of existing bonds fall.

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