Ch. 5 : MEASURING GDP AND
ECONOMIC GROWTH
–Define GDP
–Circular flow model
–Relationship between aggregate expenditure
and aggregate income.
–Measurement of real GDP and the GDP
deflator
–Real GDP as a measure of economic growth
and the limitations of our measure
Gross Domestic Product
• GDP: gross domestic product
– the market value of all final goods and
services produced in a country in a given time
period.
– This definition has four parts:
•
•
•
•
Market value
Final goods and services
Produced within a country
In a given time period
Gross Domestic Product
• GDP and the Circular Flow of Expenditure
and Income
– GDP measures the value of production
• equals total expenditure on final goods
• equals total income from production.
– The circular flow diagram illustrates the
equality of income, expenditure, and the value
of production.
Gross Domestic Product
– Red=expenditures
Blue=income
Green=borrowing/lending/taxes
Gross Domestic Product
– Two ways to measure GDP:
– Expenditure Approach:
• Aggregate expenditure = C + I + G + (X-M)
– Income Approach
• Aggregate income = Y = Wages + Rent + Interest +
Profit
– Because Income and expenditure approach
both measure GDP:
Y = C + I + G + (X-M)
Gross Domestic Product
• Financial Flows
–Y=C+S+T
– Y = C + I + G + (X-M)
•
S+T = I+G+(X-M)
(G-T) = (S-I)-(X-M)
• According to last equality, what are the
possible consequences of a larger
government budget deficit?
Gross Domestic Product
• How Investment Is Financed
– The last equation could also be reorganized
as:
I = S + (T-G) + (M-X)
• Investment is financed from three sources:
– Private saving, S
– Government budget surplus, (T – G)
• S + (T-G) is “national saving”
– Borrowing from the rest of the world (M – X).
Gross Domestic Product
• Gross vs. Net Domestic Product
• “Gross” means before accounting for the
depreciation of capital.
• Net Domestic Product = GDP – Capital
Consumption Allowance.
Gross Domestic Product
Stocks versus flows
– Wealth
• a stock representing the value of all the things that people
own
– Saving
• A flow that is the source of changes in the stock of wealth.
– Capital
• A stock representing the plant, equipment, and inventories of
raw and semi-finished materials that are used to produce
other goods
– Investment
• A flow representing the purchases of new capital
– Depreciation (capital consumption)
• A flow representing the decrease in the capital stock that
results from wear and tear, and obsolescence.
Gross Domestic Product
– The relationships among capital, gross
investment, depreciation, and net investment.
Gross Domestic Product
• Depreciation is included in:
– GDP
– Gross profits
– Gross Investment
• Depreciation is removed from
– Net National Product
– Net profits
– Net investment
• Investment plays a central role in the
economy.
– Increases in capital are one source of growth in potential real
GDP;
– Fluctuations in investment are one source of fluctuations in real
GDP.
Measuring U.S. GDP
• The National Income and Product Accounts
divide incomes into five categories
– Compensation of employees
– Net interest (paid by business)
– Rental income
– Corporate profits.
– Proprietors’ income.
• The sum of these five income components is net
domestic income at factor cost.
Measuring U.S. GDP
• Two items must be added to get GDP
–Indirect taxes minus subsidies are added to get
from factor cost to market prices.
–Depreciation (or capital consumption) is added
to get from net domestic product to gross
domestic product.
Expenditure Components of US
GDP: 2004
12,000
10,000
8,000
6,000
4,000
GDP
Consumption
Investment
Government
Net exports
2,000
0
-2,000
2004
Real GDP and the Price Level
– Nominal GDP is the value of final goods and
services produced in a given year when
valued at the same year’s prices
– Real GDP is the value of final goods and
services produced in a given year when
valued at constant (base year) prices.
Real GDP and the Price Level
• 2002 NGDP ________
• 2003 NGDP ________
• Growth rate ________
Item
Quant.
Price
2002
•
•
•
•
•
•
•
•
Base year of 2002
2002 RDGP ________
2003 RGDP ________
Growth rate ________
Base year of 2003
2002 RDGP ________
2003 RGDP ________
Growth rate ________
Balls
100
$1.00
Bats
20
$5.00
Balls
160
$1.00
Bats
22
$10.00
2003
Chain-weighted method for real GDP
1. Calculate growth rate in real GDP using last year’s
prices. ______
2. Calculate growth rate in real GDP using this year’s
prices. ______
3. Calculate the average of the two growth rates. This
average growth rate is the growth rate of real GDP
from last year to this year.
average growth rate _______
RGDP (using 2002 as base) _________
4. Repeat steps 1, 2, and 3 for each pair of
adjacent years to link real GDP back to the
base year’s prices.
Real GDP and the Price Level
• GDP deflator
• Avg. of the prices of the goods in GDP in
the current year expressed as a % of the
base year prices.
N  GDPt
GDP  deflt  100 *
R  GDPt
Interpreting the GDP-deflator
– The GDP-deflator provides a comparison of
current year prices with base year prices.
– If deflator =100, prices are, on average, the
same.
– If deflator=150, current year prices are, on
average, 1.5 times those in base year (50
percent higher)
– If deflator=75, current year prices are, on
average .75 times those in base year. (25
percent lower)
U.S. GDP-deflator
(2000=100)
19
70
19
73
19
76
19
79
19
82
19
85
19
88
19
91
19
94
19
97
20
00
20
03
120.000
100.000
80.000
60.000
40.000
20.000
0.000
Year
Measuring Economic Growth
– We use real GDP to calculate the economic
growth rate.
– The economic growth rate is the percentage
change in real GDP from one year to the next.
R-GDP as a measure of economic welfare.
1. Quality improvements
2. Household production
3. Underground economy
4. Health and life expectancy
5. Leisure time
6. Environment
7. Political freedom and social justice
8. Exchange rate in comparing across
countries.
• Exchange rates and comparisons across
countries.
– Using actual exchange rate, U.S. real GDP
per capita = 69* Chinese real GDP per capita
– Using PPP exchange rate, U.S. real GDP =
12*Chinese real GDP per capita.
• What does this say about actual versus
PPP exchange rate?