Macro Chapter 7
Taking the Nation’s
Economic Pulse
4 Learning Goals
1) Define gross domestic product and
describe the key phrases of the definition
2) List the ways to measure gross domestic
product and identify the source of higher
income levels
3) Differentiate between real and nominal
GDP
4) Examine the limitations of using GDP as
a measure of output and income
GDP – A Measure of Output
Definition of Gross Domestic
Product (GDP):
The market value of final goods and
services produced within a country during
a specific time period.
Gross National Product (GNP): The
market value of final goods and services
produced by a country’s citizens during a
specific time period.
Q7.1 A business produced $10 million of goods in
2005 but sold only $9 million. Is the $1 million
increase in inventory counted as part of the 2005
gross domestic product?
1.
2.
3.
4.
No, because inventories are intermediate goods.
No, because if these inventories were sold in 2006, they
would be counted twice.
Yes, because these inventories are part of the output of
the economy in 2005.
Yes, but they will be added to the 2005 GDP only if they
are sold in 2006.
Q7.2 George lived in a home that was newly constructed in
2005. In 2005, he paid $200,000 for the brand new house. He
sold the house in 2006 for $225,000. Which of the following
statements is correct regarding the sale of the house?
1) The 2006 sale increased 2006 GDP by $225,000 and had no
effect on 2005 GDP.
2) The 2006 sale increased 2006 GDP by $25,000 and had no
effect on 2005 GDP.
3) The 2006 sale increased 2006 GDP by $225,000;
furthermore, the 2006 sale caused 2005 GDP to be revised
upward by $25,000.
4) The 2006 sale affected neither 2005 GDP nor 2006 GDP.
GDP as a Measure of Both
Output and Income
First way to measure GDP:
expenditure approach
GDP = sum of purchases
GDP = Y = C + I + G + X
C = consumption; purchases for goods and
services by consumers
I = investment
G = government purchases
X = net exports (exports – imports)
Investment ≠ buying stocks and
bonds
Investment = businesses buying final
goods and services to use in their
production of another good
AND
consumers buying houses
Q7.3 Y = C+I+G+X. Which of the four is the
largest component of GDP?
1.
2.
3.
4.
Consumption
Investment
Government purchases
Net Exports
Class Activity: What government agency
calculates GDP? How often is GDP
calculated? How big is US GDP?
See bea.gov
Some GDP facts: 2nd quarter, 2011
GDP = $14,996 billion
That’s $14,996,800,000,000
C = 10,662 (71%)
I = 1,889 (13%)
G = 3,044 (20%)
X = -600(-4%)
(exports = 2,084 or 14%; imports = 2,684
or 18%)
Class Activity: The US is the world’s
largest economy. Name the next four
largest economies in order.
See 2010 World Bank GDP
See 2010 World Bank GDP per capita
Second way to measure GDP:
income approach
Add up income generated in the
production of goods and services
The two methods of calculating GDP are
summarized below:
Expenditure Approach
Resource Cost-Income Approach
Personal consumption expenditures
Aggregate income:
Employee Compensation
Income of self-employed
Rents
Profits
Interest
+
Gross private domestic investment
+
Government consumption
and gross investment
+
Net exports of goods and services
= GDP
+
Non-income cost items:
Indirect business taxes
and depreciation
+
Net income of foreigners
= GDP
Key Point:
Higher income levels come from (are caused by)
more output
That is, more output comes first, then higher
income comes second
Q7.4 If a used car dealer purchases a used car for
$3,000, refurbishes it, and sells it for $8,000, the
1.
2.
3.
4.
dealer contributes value added equal to $5,000, but
nothing is added to GDP.
dealer contributes value added equal to $5,000, and
consequently $5,000 is added to GDP.
dealer contributes nothing to production because only
existing goods are involved.
dealer contributes value added equal to $8,000, but
only $5,000 is added to GDP.
Q7.5 (PMA) An American-owned McDonald's opens in
Russia. How would the net revenue earned by this
restaurant affect the GDP and GNP of the United
States?
1. GNP would rise
2. GNP would fall
3. GNP would remain unchanged
4. GDP would rise
5. GDP would fall
6. GDP would remain unchanged
Adjusting for Price Changes
and Deriving Real GDP
Watch video: Austin Powers- inflation
Watch video: Stossel Macro Clip 02- gas
prices
Nominal (money) _________ = current
year data only
Real __________ = adjusted for inflation
Use a price index to adjust nominal data
into real data
These two indexes are used to
adjust nominal data to real data.
CPI: representative sample of goods
bought by households, “market basket”
GDP deflator: accounts for almost all
goods bought (broader measure than CPI)
Inflation = the percentage change in an
index
The simplest example
Suppose all prices doubled between 1950
and 2000. Then $1 in 1950 would be
equal to $2 in 2000. Or, $1 in 2000 would
be equal to $0.50 in 1950.
See “Applications in Economics” on p. 158
of text.
See also fueleconomy.gov
Q7.6 If the GDP deflator in 2006 was 130 compared
to a value of 100 during the 1996 base year, this
would indicate that
1. the inflation rate during 2006 was 30 percent.
2. the general level of prices during 2006 was 30
percent higher than during 1996.
3. the inflation rate during 2006 was 130 percent.
4. nominal GDP grew by 30 percent during 2006.
5. real GDP was 130 percent higher in 2006 than
1996.
Problems with GDP as a
Measuring Rod
What GDP misses:
1) Non-market transactions like household
work
2) Unreported and illegal transactions
3) The value of leisure and “time off”
4) Quality changes
5) Negative side effects like pollution
So, GDP is a measure of output but it’s not
the measure of output
It’s a good measure, but not a perfect
measure
Question Answers
7.1 = 3
7.2 = 4
7.3 = 1
7.4 = 2
7.5 = 1 & 6
7.6 = 2