Unit 1 – Macroeconomic
Measurement and Basics
Concepts
Chapter 7 – Measuring Domestic
Output and National Income
Essential Questions
1. How do we measure the nation’s economic
output?
2. How do we compare the nation’s economic
output from year to year in the face of
changing prices?
National Income Accounting measures the economy’s
overall performance.
The most commonly used measure is Gross Domestic
Product (GDP).
GDP is the total market value of all final goods and
services in a given year produced by resources employed
within this country.
- Must avoid multiple counting:
- Count only final goods or
- Count only value added at each step.
Avoiding multiple counting (example):
George has a sheep farm. He produces a bushel of wool.
Eunice has a textile mill, she buys the wool from George for
$100 and produces cloth.
Ellen is a tailor. She buys the cloth from Eunice for $200
and makes a suit that she sells to Dao for $300.
How much do we count toward GDP?
1. Either count just the final good – the $300 suit.
2. Or count the value that each person added:
- George produced $100 worth of wool.
- Eunice added $100 of value to that wool to make $200
worth of cloth.
- Ellen added $100 of value to that cloth to make a $300
suit.
$100 + $100 + $100 = $300
GDP excludes “non-production” transactions:
1. Financial transactions
a. Public transfer payments
b. Private transfer payments
c. Stock market transactions (brokers fees are included).
2. Second-hand sales. (anything “used”)
There are two methods of computing GDP: Spending and
Income. We’re going to look at the spending, or Expenditures
Approach.
But, and this is very important, the income approach gives you
the same result. GDP
= NATIONAL INCOME.
The Expenditures Approach - Add together all of these:
1. Personal Consumption Expenditures (C)
2. Gross Private Domestic Investment (Ig)
a. Final purchases of machinery, equipment and tools by
businesses.
b. All construction.
c. Changes in inventories (can be positive or negative).
3. Government Purchases (G)
4. Net Exports (Xn)
(Exports – Imports) (example of the Toyota factory in Kentucky)
GDP = C + Ig + G + Xn
Nominal GDP vs. Real GDP
Year 2000 – We produce 1 car with a final price tag of $25,000.
So GDP for 2000= $25,000
Year 2013 - We produce the same kind of car with a final price
tag of $30,000
So GDP for 2013 = $30,000
OK, we know that doesn’t really reflect reality. Output did not
actually grow. We call these figures nominal GDP.
Nominal GDP vs. Real GDP
Year 2000 – We produce 10 cars ($15,000 each) and 40
computers ($500 each).
(10 x 15,000) + (40 x 500) = $170,000
So GDP for 2000 = $170,000
Year 2013 - We produce 10 cars ($20,000 each) and 40
computers ($625 each)
(10 x 20,000) + (40 x 625) = $225,000
So GDP for 2013 = $225,000
Again, output did not actually grow. Only nominal GDP
increased.
Nominal GDP vs. Real GDP
Year 2000: Nominal GDP = $170,000
Year 2013: Nominal GDP = $225,000
Real GDP is how we adjust these numbers to show actual
growth.
First, choose a base year. We’ll use 2000. Then we calculate a
price index for that year.
Price Index = Value of market basket in a given year x 100
Value of market basket in base year
So the Price Index for the base year is always 100.
Nominal GDP vs. Real GDP
Year 2000: Nominal GDP = $170,000
Year 2013: Nominal GDP = $225,000
Price Index for 2000 is 100.
Price Index for 2013 =
Value of market basket in 2013
Value of market basket in 2000
x 100
Let’s say our market basket is 1 car and 1 computer.
Price Index for 2013 = 20,625 x 100 = 133
15,500
Nominal GDP vs. Real GDP
Year 2000: Nominal GDP = $170,000
Year 2013: Nominal GDP = $225,000
Price Index for 2013 = 20,625 x 100 = 133
15,500
Now we can calculate Real GDP for 2013:
__Nominal GDP__ = $225,000
(Price Index ÷ 100)
(133/100)
= $225,000 = $169,172
1.33
OK, this is close, but shouldn’t they be exact if we produced
the exact same amount of goods? Anybody have any
explanations for this?
Nominal GDP vs. Real GDP
To summarize:
To find Real GDP:
Divide Nominal GDP by (Price Index/100).
Price Index is also called the GDP Deflator because you use
it to deflate inflated Nominal GDP figures back to Real GDP
figures.
And one last thought: the Price Index (GDP Deflator) can
sometimes actually be an inflator if the price index is less than
100.
Year
Nominal GDP
Price Index
Real GDP
(In Billions of $) (GDP Deflator) (In Billions of $)
1980
2795.6
57.05
1985
4213.0
73.69
1990
5803.2
6707.9
1995
7400.5
7543.8
1996
7813.2
7813.2
2002
10,446.2
110.66
1. Complete this table.
2. Which one of these is probably the base year? How
do you know?
Year
Nominal GDP
Price Index
Real GDP
(In Billions of $) (GDP Deflator) (In Billions of $)
1980
2795.6
57.05
4900.3
1985
4213.0
73.69
5717.2
1990
5803.2
86.51
6707.9
1995
7400.5
98.10
7543.8
1996
7813.2
100
7813.2
2002
10,446.2
110.66
9439.9
1. Complete this table.
2. Given that the base year is one of these years, which
one is it? How do you know?