Chapters 6 and 7
Introduction to Macroeconomics
Measuring Domestic Output and
National Income
1
Intro to Macroeconomics
Macroeconomics: Study of the economy as a whole
• Concerned with variables such as unemployment,
inflation and measures of total production
3 Macroeconomic Goals
1) Modern Economic Growth
-- ability of economy to produce increasing quantities
of goods and services (economic growth) above the
increase in population  rise in output per person
-- variable used to measure economic growth is known
as real GDP or real Gross Domestic Product (a.k.a
aggregate or total output)
-- leads to increase in avg standard of living
2
3 Macroeconomic Goals
2) High Employment
Unemployment: % of workforce that would like to
work but can not find jobs
-- some level of unemployment is actually healthy
for the economy
3) Stable Prices
-- When we refer to changes in the price level, we
are referring to inflation
Inflation: rise in the general level of prices in
economy
-- Inflation has an affect on the purchasing power of
a currency (i.e. if prices increase from one year to
next, $1 today buys less than it did a year ago)
3
Relationship Between Economic Growth and Employment
-- High levels of Output = High levels of employment
-- Low levels of Output = Low levels of employment
Business Cycle
-- Periodic fluctuations in output (real GDP) around the long
term growth trend.
-- Periods of economic expansion and economic recession
4
Real GDP Trend For a Hypothetical Economy
Real GDP
Business Cycle
Year
1940
1950
1960
1970
1980
1990
5
Real GDP Trend For a Hypothetical Economy
Real GDP
A
B
1950
Expansion
Expansion
1960
Recession
Year
Expansion
Recession
6
Business Cycles
a) Expansion: a period of increasing production or output
(i.e. increase in real GDP)
-- continues until there is a peak (point where GDP
reaches its highest level during an expansion) or pt A
-- increase in real GDP is above normal levels
b) Recession: a period of declining production or output (i.e.
decline in real GDP)  most explicit sign
-- continues until there is a trough (point where GDP
reaches its lowest level during a recession) or pt B
-- recessions can also occur when real GDP is growing at
below normal rates
Depression: long lasting recession
More on this topic in later chapters
7
Measuring GDP
Gross Domestic Product (GDP)
-- simple definition: measure of total production or output
in the economy (aggregate output)
-- standard definition: market value of all final goods and
services produced for the marketplace during a period of
time, within the nation’s borders.
Breakdown of definition:
a) “market value”: GDP is measured by the dollar value of
all final good and services
8
Advantages of using the value of good/service vs.
some other measure:
1) gives us a common unit of measurement
w/out common measurement
 5 bushels of wheat + 5 lbs of apples = ?
w/common measurement ($)
 $25.00 for wheat + $5.00 for apples = $30.00
-- as stated in the business world  this is now an
apples to apples comparison
2) Accounts for the value of higher price goods
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b) “of all final”: focuses exclusively on the value of the final
good or the good sold to the final user.
-- excluding the value of intermediate goods used to
make the final good
Intermediate Goods
-- goods used up in producing the final good or goods
used as inputs for other goods
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Example: Truckload of gasoline
Step
Action
Sales Value
1
Oil company extracts petroleum and sells to refinery
$15,000
2
Refinery converts petroleum to gasoline
$25,000
3
Gas Station sells to customers
$28,000
-- For GDP, we only count the value of the product sold to the
final user (step 3) or $28,000
-- value of intermediate goods (i.e. petroleum) are already
included in the value of the final good
Note:
Capital Goods (long-lived goods used in the production of other
goods/services) such as buildings, machines, etc are not classified as
final goods (they’re used to produce other goods) or intermediate goods
(they’re not used up in the production process)  included in GDP when
they are initially produced or new.
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c) “goods and services”: GDP includes both goods and
services.
-- Services such as lawn care and medical exams
-- Goods such as toys, new cars and electronics
d) “produced”: GDP includes only goods and services produced
Examples of items not produced:
1) Sale of Land – natural resource
2) Financial Assets (stocks/bonds) – right to receive future
payments
3) Transfer Payments (Public and Private) – social security
payments, welfare payments, birthday money
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e) “for the marketplace”: GDP only includes
goods and services intending to be sold.
•
•
does not include goods/services that you provide
for yourself but don’t receive payment
e.g.) mowing own lawn, washing own car,
watching neighbor’s children
does not include volunteer work
Note:
-- goods/services provided by the Federal/State/Local
Govt’s such as education and national defense
although not sold in the marketplace are included in
GDP
13
f) “during a period of time”: GDP includes goods and
services produced during a specific time frame being
analyzed
-- does not include the value of used goods
-- part of GDP in earlier yr when they were new
g) “within the nation’s borders”: GDP includes only those
goods/services produced within a nation’s borders
-- relating to the U.S., goods and services must be
“Born in the USA”
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2 Approaches to Measuring GDP
I) Expenditure Approach
-- measure GDP by adding the value of goods and services
purchased by each type of final user (Households, Firms,
Gov’t and Foreign Sector)
-- sum of the money spent to buy the output
-- 4 Categories
1) Personal Consumption Expenditure or simply
Consumption (C)
2) Gross Private Domestic Investment or simply
Investment (Ig)
3) Gov’t Consumption and Gross Investment or simply
Gov’t Purchases (G)
4) Net Exports (Xn)
GDP = C + Ig + G + Xn
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1) Consumption Expenditure or simply Consumption (C)
-- largest component of GDP (about 70%)
-- part of GDP purchased by households
-- subdivided into the following:
a) Services (e.g. medical care, education, lawn
care)  largest component of C category
b) Nondurable goods (e.g. food and clothing)
-- Goods with expected lifespan of less than 3 yrs
c) Durable Goods (e.g. automobiles, furniture,
appliances
-- Goods with expected lifespan of 3 or more yrs
-- items not part of GDP
1) Used Goods
3) Do it yourself projects
2) Land
4) Financial Securities
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-- special items included in GDP but are estimated values
1) total value of all food products that farm families
produce and consume themselves
2) Value of shelter from owner occupied homes
-- New home construction (which normally would fall into
this category) is included elsewhere
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2) Gross Private Domestic Investment (Ig)
-- spending by firms on final goods/services, including
new home or residential construction
-- purchasing capital stock (goods that will provide useful
services in the future)
Subdivided into the following:
i) Business Fixed Investment
-- business purchase of new plant and equipment
(e.g. telephone, machinery, buildings & computers)
-- largest component of Ig category
ii) Residential Investment
-- New Home construction is considered an investment
because it could be translated into a business venture
(rental property)
-- not part of C since Gov’t considers it to be capital stock
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iii) Change in Inventories
-- inventories are goods that have been produced but not
yet sold.
-- require special attention depending on whether we are
accumulating inventories or depleting them.
a) Increase in inventories (a.k.a capital formation)
e.g.)
•
•
•
$2 billion in unsold boats go into inventory
$18 billion in boats sold are accounted for in
Consumption (C) and $2 billion needs to be
accounted for in Ig category or
GDP = $18 billion + $2 billion or $20 billion.
not accounting for ↑ in inventories would
underestimate GDP
19
b) Decrease in inventories
e.g.
•
•
•
•
$2 billion over production must have come from
inventories
$2 billion is then deducted from GDP as part of
inventory changes
GDP = $22 billion (Consumption) - $2 billion
(Investment) or $20 billion
Not accounting for ↓ in inventories would
overestimate GDP
20
3) Government Purchases (G)
-- spending by Federal, State and Local Gov’t on final
goods and services
• goods such as police cars, buildings, etc
• services such as military, police, agencies, education
Transfer Payments: type of gov’t spending involving the
redistribution of funds from one group in society to
another (e.g. social security, welfare & unemployment)
-- since they do not involve the purchase of goods and
services, they are not included in GDP
21
4) Net Exports (Xn)
a) Imports: goods produced outside the U.S. but sold in
the U.S.
-- in GDP, we must subtract their value from the
calculation since they’re accounted for in Consumption
but were not produced within the country (i.e. must be
“Born in the USA”)
b) Exports: goods produced within the U.S. but sold to
foreign firms, gov’t or households
-- in GDP, we must add their value in the calculation
since they’re not accounted for anywhere else
Net Exports (Xn) = Exports – Imports
-- indicator of the balance of trade
22
Example
23
2006 GDP (Current $)
Components of GDP (billions of dollars)
Consumption (C)
Durable Goods
$9,224.5
$1,048.9
Nondurable Goods
2,688.0
Services
5,487.6
Investment (Ig)
Business Fixed
2,209.2
1,397.7
Residential Construction
764.8
∆ in Business Inventory
46.7
Gov’t Purchases (G)
Federal
State and Local
2,523.0
932.5
1,590.5
Net Exports (Xn)
-762
Exports
1,467.6
Imports
2,229.6
Total GDP
$13,194.7
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2 Approaches to Measuring GDP
II)
Income Approach to Calculating GDP
-- GDP as measured by the Income derived from producing it
-- Whenever a good or service is sold, revenue from the sale
is used for factor payments.
-- Factor Payments are payments made to the owners of the
resources used in producing a good (factors of production)
GDP = National Income - Net Foreign Factor Income +
Statistical Discrepancy + Consumption of Fixed Capital
National Income
-- income that flows to domestic or foreign Americanowned resources + taxes on production & imports
a) Private income (employee compensation,
rents, interest, proprietor’s income and corporate
profits)
b) Govt revenue from taxes on production & imports
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2 Approaches to Measuring GDP
Net Foreign Factor Income
- deduct income Americans gain from supplying resources
abroad and adding in income that foreigners gain from
supplying resources in the U.S.
Statistical Discrepancy
-- added to national income to bring into alignment with
Expenditure approach to calculating GDP
Consumption of Fixed Capital
-- allowance made for depreciation of capital
-- allowance for capital that is consumed in producing the
given year’s GDP
-- included in the value of output but not included in
national income so we have to add it back in
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2 Approaches to Measuring GDP
National Income
1) Wages, salaries and incomes of employees
- largest component of national income
2) Rents: income received by households and businesses that
supply property resource
3) Interest: money paid by private businesses to suppliers of
loans to purchase capital
4) Proprietor’s Profit: profit earned by sole proprietorships,
partnerships and other unincorporated businesses
5) Corporate Profit: Earnings of Corporation
a) Corporate Income Taxes: corporate taxes
b) Dividends: after tax profits distributed to shareholders
c) Retained Earnings: after tax profits retained by
corporations
6) Taxes on Production and Imports: general sales tax, excise
taxes, business property taxes, license fees and customs
duties
- income for Gov’t
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Example
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Measuring GDP Summary:
GDP = Sum of all final goods and services
produced in the economy (some
exceptions)
GDP = C + Ig + G + NX
GDP = National Income - Net Foreign Factor
Income + Statistical Discrepancy +
Consumption of Fixed Capital
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GDP: Real versus Nominal
•
GDP, measured in $ value, can be influenced by
changes in quantity, changes in price or both
Revenue = price x quantity
•
Given this influence, it’s important to mitigate changes in
price and allow quantity to the sole determinant of
changes in GDP.
2 Types of GDP
Nominal GDP: GDP as measured by the value of final
goods and services at current year prices
Real GDP: GDP adjusted for changes in the dollar
value or changes in the price level (adjusted for
inflation)
-- uses base year price levels to measure value of
current production
-- measure of the actual physical volume of production by
mitigating the influence of price changes
30
Index Numbers: way of measuring variable
over time by using base period values
Index Number = Current Period Value
Base Period Value
x 100
-- Index # in base period is 100
-- base periods are chosen because they
represent a “normal” year for the variable in
question and therefore is a good benchmark
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Price Index
Price Index Yr A = Cost of Market Basket in Yr A____
Cost of Market Basket in Base Year
x 100
• ratio of the dollar amt necessary to buy the market basket of
goods in given year divided by the dollar amt necessary to buy
the market basket in base year
• Market basket is a collection of goods
Example: Assume the following
-- 1983 is the base year / 1983 Market Basket = $200 billion
-- 1990 Market Basket = $261.4 billion
Price Index1990 =
Price Index
=
1983
=
_____in
base Yr
=
Interpretation: It costs _____% more for the basket of goods in
1990 versus 1983 or prices rose by _____% 
_____% derived as follows
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Using Price Index to Calculate Real GDP
•
Deflating nominal GDP or adjusting for inflation
Real GDP Yr A =
Nominal GDP Yr A
_________________
Converting
back to decimal
Price Index (hundredths) Yr A
Example: Find 1995 Real GDP
Nominal GDP = $350 billion Price Index = 150.00
Real GDP = 350 / 1.50
= 233.33 billion
Note: Gov’t uses a price index called chain-type annual-weights,
which is more complex than the price index illustrated here
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Using Base Year Price Levels to calculate Real GDP
•
Using Base Year price levels (in lieu of current) and the current year
quantities to calculate GDP
•
Price levels in base year are used to calculate the value of the
goods and services
•
Normally real GDP is less than Nominal GDP for years following the
base year
Example: Find Real and Nominal GDP for 2006 (2000 is base year)
Year 2000
Product
Price
Year 2006
Quantity
Price
Textbooks
$50.00
100
$60.00
Hamburgers
$2.00
100
$2.00
Shirts
$30.00
50
$25.00
Cotton
$.80
8,000
$.75
Nominal GDP =
Real GDP =
34
Notes relating to GDP data on Bureau of Economic
Analysis website:
• www.bea.gov provides historical and current nominal
and real GDP for both quarterly and yearly time frames
• Includes GDP info within sectors as discussed via
Expenditure approach (i.e. Personal Consumption,
Gross Private Domestic Investment, etc)
• Includes GDP info by industry
• Quarterly info is seasonally and annually adjusted
including percent change values.
• In order to match quarterly % change values using
seasonally annual adjusted values, you need to multiply
by 4.
• Reference to “chained” values corresponds to Gov’t
measure of real GDP using the chained-weighted
approach
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GDP May Not Reflect True Economic Well-Being
-- Certain factors associated with societies’ true economic wellbeing are not part of GDP such as:
1)
Benefits of Leisure Time
 Both Individuals and Society benefit from some level
of leisurely activities
2)
Non-Market Economic Activities
 Volunteer services, unpaid services, underground
economies, “under the table” or cash compensations,
bartering, etc are all part of society and may
understate level of economic activity
 Degree of understatement depends on whether you
are a developing or industrialized nation 
developing nations probably have higher rates of nonmarket activities
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3) Environmental Effects

Both positive and negative
4) Degree of Economic Inequality


Is 90% of the economy controlled by a handful of
people or is it more evenly distributed?
Two economies with similar levels of GDP may have
different distributions of wealth
Importance of GDP



Used to monitor business fluctuations (recessions &
expansions) – Not sole indicator of a recession
Makes assumptions about the overall health of the
economy
Strong correlation to economic well-being of a country
(although not perfect)
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