Principles of Macroeconomics
ECON203,
Lecture 6: GDP and Related Measures of
Production and Income
Instructor: Turki Abalala
Recap of Last Lecture
 GDP and other related measures
 Nominal GDP and Real GDP
 GDP Deflator
 Inflation Rate and Consumer Price Index
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Class Outline
 The Use of Real GDP
 The business Cycle and Potential GDP
 The Limitations of GDP
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The Use (importance) of Real GDP
 We use estimates of real GDP for three main purposes:
• To compare the standard of living over time
• To track the course of the business cycle
• To compare the standard of living among countries
 The Standard of Living Over Time
• To compare living standards we calculate real GDP per
person—real GDP divided by the population.
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The Business Cycle
 The business cycle is the periodic but irregular up-and-down
movement of total production and measures of economic activities.
•
Every business cycle has two phases:
1.Expansion (Increase in R.GDP and positive economic growth)
2.Recession (Decrease in R.GDP and negative economic growth)
And two turning points:
1.Peak (where expansion ends and recession begins)
2.Trough (where recession ends and expansion begins)
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The Business Cycle
Real GDP
Peak
Expansion
Recession
Trough
Time
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The Use and Limitations of Real GDP
 Two features of our changing standard of living are
1. The growth of potential GDP per person
2. Fluctuations of real GDP per person around potential GDP
 Potential GDP is the value of real GDP when all the economy’s
factors of production —labor, capital, land, and
entrepreneurial ability—are fully employed.
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The Use and Limitations of Real GDP
 When some factors of production are unemployed, real GDP is
less than potential GDP.
 When some factors of production are over-employed and
working hard, real GDP exceeds potential GDP.
 In the short term, real GDP fluctuates around potential GDP.
 To measure the trend in the standard of living, we remove the
influence of short-term fluctuations and focus on potential
GDP .
 The figure on next slide shows these two features.
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The Use and Limitations of Real GDP
Real GDP per person
grows and fluctuates
around the path of
potential GDP .
Potential GDP per
person grew at 2.8
percent in the 1960s
and slowed during the
1970s.
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The Use and Limitations of Real GDP
 Goods and Services Omitted from GDP
• Household production
• Underground production
• Leisure time
• Environment quality
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The Use and Limitations of Real GDP
1. Household production of goods and services: Because these are
not bought or sold in the market. So, GDP underestimates the
value of production.
2. Underground Production: it is the production of goods and
services hidden from government to avoid taxes and regulations
or their actions are illegal. Underground Production is unreported
so it is omitted from GDP
3. Leisure Time: It is an economic good . You must choose between
work or leisure time. When leisure time increases that means our
standard of living increases. The improvements of our standard of
living are not measured in real GDP.
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The Use and Limitations of Real GDP
4.
Environment quality:
Pollution is an economic evil. The more we pollute our
environment, the lower is our standard of living(other things
being the same). This lowering of our standard of living is not
measured in GDP.
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The Use and Limitations of Real GDP
 Other Influences on the Standard of Living :
1. Health and life expectancy:
Good health and long life do not show up directly in GDP. On the other
side we do not take into account the negative effect of bad
diseases.
2. Political freedom and social justice:
A country might have a very large GDP per person but have limited
political freedom and social justice. Such a country would be
regarded as having lower standard of living
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Reference
Chapter 5 of “Foundations of Macroeconomics”
Pages127-132
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Now it’s over for today.
Any question?
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