Chapter 8 homework
• Number 4: Matt Herr
• Number 6: Carolyn Kostanzer
• Number 8: Carlos Perez
• Number 16: Risa Satomura
• Number 18: Robert Saunders
• Alternate: Kyoko Yamashita
Chapter 9
GDP and the
Business Cycle
Does a higher GDP mean that the
economy is better???
We can calculate it…how do we interpret
it???
Real and Nominal GDP
• Nominal GDP is the market value of
new output evaluated at the output’s
current market price.

When nominal GDP changes, it could be
due to a change in output, a change in
prices or a change in both.
• We need a measure that changes
only when there is a change in the level
of output.
Real and Nominal GDP
• Real GDP is the value of the economy's
output at constant dollars.

Real GDP is calculated using prices from a
base year.
• Because it is calculated using constant
prices, real GDP changes only when
output changes.
The GDP Deflator
• Since nominal and real GDP are calculated
using prices from different years, they can
be used to measure general price changes in
the economy.
GDP Deflator 
Nominal GDP in Current Year
100
Real GDP in Current Year
• Unlike the CPI (only included Consumption
goods), the GDP deflator includes the prices
of all goods and services produced in the
United States.
The GDP Deflator (cont’d)
• Example: Nominal GDP in 2004 was
$11.7T and real GDP with 2000 as the
base year was $10.8T. The GDP
deflator was:
$11.7 Trillion
100  108
$10.8 Trillion

Interpretation: Prices rose by 8% between
2000 and 2004.
How is this different from the CPI???
• CPI calculated from a “basket of goods”
that people buy
• GDP deflator includes these as well as
capital goods

New plant and equipment
• And good and services sold to foreign
households
Real GDP Per Capita
• If one nation has higher real GDP than
another, that doesn’t necessarily mean
its residents have higher incomes.

Why? Because population varies across
countries.
• Real GDP per capita measures a
country’s real income per person.

Found by dividing a nation’s real GDP by
its population.
Real GDP and the Quality of Life
• Real GDP is the single best measure of
a nation’s average income, but there are
problems with using GDP as a measure
of welfare.
Real GDP and the Quality of Life (cont’d)
• GDP counts some production that does not
add to the quality of life.

Examples: Spending on crime prevention and
military weapons
• Real GDP ignores non-market activities that
add to the quality of life.

Examples: Meals prepared at home, cleaning your
house are not included doing your laundry
• Unless you hire someone to do it for you
Real GDP and the Quality of Life (cont’d)
• GDP ignores the role of leisure in the
quality of life.

Leisure activities represent forgone production,
and are therefore not counted in GDP.
• GDP ignores production in the underground
economy.


There are some transactions that never get
recorded in official statistics.
How much???
• Some suggest that about 8–9% of the official GDP of the
United States.
Real GDP and the Quality of Life (cont’d)
• Uneven income distribution may affect
well-being.

Neither GDP nor GDP per capita takes the
distribution of income into account.

Who has the money??
Life Lessons
• The grass isn’t always greener even if the
money is.

In 2004, GDP per capita in the United States
was approximately $40,000, compared to
$28,000 in France. Yet there was not a large
number of people looking to immigrate from
France to the United States.

Compared to the French, Americans:
• Work longer hours and have fewer vacations
• Pay for more services such as healthcare
and childcare