Introduction to Macroeconomics
Chapter 4
Measuring Output of the Macroeconomy

Chapter 4. Measuring the Macroeconomy
1. Measuring Total Output
2. How to Measure GDP
3. GDP Accounting Complications
4. Nominal and Real GDP
5. Measuring Price Changes
6. Empirical Applications
Introduction to Macroeconomics

1. Measuring Total Output
• Monetary Measure of Value
• GDP versus GNP
• Omissions from GDP - does not measure social welfare
Introduction to Macroeconomics

1. Measuring Total Output
Monetary Measure of Value
Quantity times Price equals Market Value
Cars 1,000 x $20,000 = $20,000,000
Dolls 10,000 x $ 10 = $ 100,000
Total Value of Output = $20,100,000
Introduction to Macroeconomics

1. Measuring Total Output
GDP versus GNP
• Nominal Gross Domestic Product (GDP) the market value of final goods and services (i.e., sold to final consumers) produced by a nation during a specific period, usually 1 year.
• Nominal Gross National Product (GNP) the market value of final goods and services produced by labor and property supplied by the residents of a nation during a specific period, usually 1 year.
Introduction to Macroeconomics

1. Measuring Total Output
Omissions from GDP
GDP is a poor measure of social welfare:
• Leisure
• Home and volunteer labor
(non market production)
• Depletion of nonrenewable resources
• Unregulated pollution
• Distribution of income
• Differences in preferences
Introduction to Macroeconomics

2. How to Measure GDP
• Circular Flow
• Expenditure Approach
• Income Approach
Introduction to Macroeconomics

2. How to Measure GDP
Circular Flow of Income and Expenditures
Income
Resources
Households
Business
Firms
Goods and Services
Expenditures
Solid Lines - Flow of Money
Dashed lines - Flow of Goods and Services
Introduction to Macroeconomics

2. How to Measure GDP
Expenditure Approach
• GDP = Consumption Spending (C)
+ Private Domestic Investment (I)
+ Government Spending (G)
+ Exports - Imports (net exports, NX)
• GDP = C + I + G + NX
Introduction to Macroeconomics

2. How to Measure GDP
Expenditure Approach: Expenditure Shares
2002 U.S. Nominal Gross Domestic Product
Government Spending
18.8 %
Consumption
69.9 %
Investment
15.2 %
Net Exports = - 4.1 % (not shown in slide)
Introduction to Macroeconomics

2. How to Measure GDP
Expenditure Approach: Consumption
75%
70%
65%
60%
55%
50%
45%
40%
1959 1969 1979
U.S.
Japan
1999
U.S. 68.2 %
Japan 60.1 %
1989 1999
Introduction to Macroeconomics

2. How to Measure GDP
Expenditure Approach: Government
35%
30%
25%
20%
15%
10%
5%
0%
1959 1969 1979
U.S.
Japan
1999
U.S. 17.6 %
Japan 18.4 %
1989 1999
Introduction to Macroeconomics

2. How to Measure GDP
Expenditure Approach: Investment
35%
30%
25%
20%
15%
10%
5%
0%
1959 1969
Japan
1979
U.S.
1999
U.S. 17.9 %
Japan 20.0 %
1989 1999
Introduction to Macroeconomics

2. How to Measure GDP
Expenditure Approach: Net Exports
6%
4%
2%
0%
-2%
-4%
-6%
1959 1969
Japan
U.S.
1979
1999
U.S. - 3.7 %
Japan 1.5 %
1989 1999
Introduction to Macroeconomics

2. How to Measure GDP
Income Approach
• National Income = GDP
(with corrections)
• Personal Income = National Income
(with corrections)
• Personal Income
- Personal income taxes
- Social Security withholding
= Disposable Personal Income
Introduction to Macroeconomics

3. GDP Accounting Complications
• Double Counting
• Depreciation
Introduction to Macroeconomics

3. GDP Accounting Complications
Double Counting
• Intended for “final” use
– excludes intermediate products
• Value Added
– excludes used goods
Introduction to Macroeconomics

3. GDP Accounting Complications
Depreciation
Gross Investment
- Depreciation
= Net Investment
Gross Domestic Product (GDP)
- Depreciation
= Net Domestic Product (NDP)
Introduction to Macroeconomics

4. Nominal and Real GDP
• Definitions
• Sample Problem
• GDP Growth
Introduction to Macroeconomics

4. Nominal and Real GDP
Definitions
• Nominal GDP
– Value of output measured at actual prices
(current dollar output)
– Does not correct for inflation
• Real GDP
– Value of output based on prices of some base period (“constant” dollar output)
– eliminates effect of inflation
Introduction to Macroeconomics

4. Real GDP
Sample Problem
Average Prices
1992 1994 % Change 1992 1994
Food
Housing
Fun
Machines
$ 12 $ 14 17 %
9 10 11 %
4
20
5
20
25 %
0 %
Quantity Sold
4
3
3
2
5
3
4
2
Introduction to Macroeconomics

4. Real GDP
Definition of Nominal GDP
Nominal GDP
= Current year Quantities x Current year Prices
Introduction to Macroeconomics

4. Real GDP
Sample Problem: 1992 Nominal GDP
= 1992 Quantities x 1992 Prices
= 1992 Spending on
Food Housing Fun Machines
= 4 • $12 + 3 • $9 + 3 • $4 + 2 • $20
= $48 + $27 + $12 + $40
= $127
Introduction to Macroeconomics

4. Real GDP
Sample Problem: 1994 Nominal GDP
= 1994 Quantities x 1994 Prices
= 1994 Spending on
Food Housing Fun Machines
= 5 • $14 + 3 • $10 + 4 • $5 + 2 • $20
= $70 + $30 + $20 + $40
= $160
Introduction to Macroeconomics

4. Real GDP
Definition of Real GDP
Real GDP
= Current year Quantities x Base year Prices
Introduction to Macroeconomics

4. Real GDP
Sample Problem: 1992 Real GDP
= 1992 Quantities x 1992 Prices
Food Housing Fun Machines
= 4 • $12 + 3 • $9 + 3 • $4 + 2 • $20
= $48 + $27 + $12 + $40
= $127
Introduction to Macroeconomics

4. Real GDP
Sample Problem: 1994 Real GDP
= 1994 Quantities x 1992 Prices
Food Housing Fun Machines
= 5 • $12 + 3 • $9 + 4 • $4 + 2 • $20
= $60 + $27 + $16 + $40
= $143
Introduction to Macroeconomics

4. Real GDP
Sample Problem: GDP Growth
• Growth in Nominal GDP
= (160 - 127) • 100 = 26%
127
• Growth in Real GDP
= (143 - 127) • 100 = 13%
127
Introduction to Macroeconomics

5. Measuring Price Changes
• Price index
• GDP deflator
• Consumer price index
• Problems with price indexes
Introduction to Macroeconomics

5. Measuring Price Changes
Price indexes
• Price Index : a measure of the change in the average level of prices
• GDP Deflator
– Base-year prices
– Quantities variable
– Imports excluded
• Consumer Price Index
– Base year quantities
– Prices variable
– Imports included
Introduction to Macroeconomics

5. Measuring Price Changes
GDP deflator
GDP Deflator = Nominal GDP • 100
Real GDP
1992 GDP Deflator = 127 • 100 = 100.0
127
1994 GDP Deflator = 160 • 100 = 111.9
143
Introduction to Macroeconomics

5. Measuring Price Changes
Inflation
Change in Average Level of Prices
= Percent Change in GDP Deflator
Inflation from 1992 to 1994
= (1994 Deflator - 1992 Deflator) • 100
1992 Deflator
= (111.9 - 100.0) • 100 = 11.9%
100.0
Introduction to Macroeconomics

5. Measuring Price Changes
Problems with price indexes
• Substitution bias - changes in relative prices
– between goods (butter vs margarine)
– between stores (small vs large discounters)
• Quality changes and new products
• Chain-weighted indexes
Introduction to Macroeconomics

6. Empirical Applications
• Use Real rather than Nominal values
• Compare Per Capita rather than
Aggregates
• Compare Growth Rates rather than
Levels
Introduction to Macroeconomics

6. Empirical Applications
Compare Per Capita rather than Aggregates
Real GDP Per Capita, 1929 - 2002
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
$0
1929 1939 1949 1959 1969 1979 1989 1999
Source: Bureau of Economic Analysis (www.bea.doc.gov)
Introduction to Macroeconomics

6. Empirical Applications
Compare growth rates rather than levels
5%
4%
3%
2%
10-year Changes in Real GDP Per Capita
4.59%
2.39%
3.03%
2.19%
2.05%
1.78%
1%
0%
0.59%
1930-
1939
1940-
1949
1950-
1959
1960-
1969
1970-
1979
1980-
1989
Source: Bureau of Economic Analysis (www.bea.doc.gov)
1990-
1999
Introduction to Macroeconomics