Chapter
10
Measuring a Nation’s Income
The Economy’s Income and Expenditure
• Gross Domestic Product (GDP)
– Measures the total income of everyone in the
economy
– Measures the total expenditure on the
economy’s output of goods and services
• For an economy as a whole
– Income must equal expenditure
• Circular-flow diagram – assumptions:
• All goods and services – bought by households
• Households - -spend all of their income
2
Figure 1
The circular-flow diagram
Households buy goods
and services from firms,
and firms use their
revenue from sales to
pay wages to workers,
rent to landowners, and
profit to firm owners.
GDP equals the total
amount spent by
households in the
market for goods and
services. It also equals
the total wages, rent,
and profit paid by firms
in the markets for the
factors of production.
3
Measurement of Gross Domestic Product
• Gross domestic product (GDP)
– Market value of all final goods and services
– Produced within a country
– In a given period of time
• “GDP is the market value…”
– Market prices - reflect the value of the goods
4
Measurement of Gross Domestic Product
• “… of all…”
– All items produced in the economy
• And sold legally in markets
– Excludes items that are:
• Produced and sold illicitly, or
• Produced and consumed at home
• “… final…”
– Value of intermediate goods is already
included in the prices of the final goods
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Measurement of Gross Domestic Product
• “… within a country…”
– Goods and services produced domestically,
regardless of the nationality of the producer
• “… in a given period of time”
– A year or a quarter
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The Components of GDP
• Y = C + I + G + NX
– Identity
– Y = GDP
– C = consumption
– I = investment
– G = government purchases
– NX = net exports
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The Components of GDP
• Consumption
– Spending by households
– On goods and services
– Exception: purchases of new housing
• Investment
– Spending on capital equipment, inventories,
and structures
– Including household purchases of new
housing
– Inventory accumulation
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The Components of GDP
• Government purchases
– Government consumption expenditure and
gross investment
– Spending on goods and services
– By local, state, and federal governments
– Does not include transfer payments
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The Components of GDP
• Net exports = Exports - Imports
– Exports
• Spending on domestically produced goods by
foreigners
– Imports
• Spending on foreign goods by domestic residents
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The components of U.S. GDP
• 2007, GDP of the United States = $14 trillion
• GDP per person = $45,838
– Consumption = $32,225 per person
– Investment = $7,061 per person
– Government purchases = $8,912 per person
– Net exports = –$2,360 per person
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Real Versus Nominal GDP
• Total spending rises from one year to the next
– Economy - producing a larger output of goods
and services
– And/or goods and services are being sold at
higher prices
• Nominal GDP
– Production of goods and services
– Valued at current prices
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Real Versus Nominal GDP
• Real GDP
– Production of goods and services
– Valued at constant (or base year) prices
– Designate one year as base year
– Not affected by changes in prices
• For the base year
– Nominal GDP = Real GDP
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Table
2
Real and Nominal GDP
Prices and Quantities
Year
Price of
hot dogs
Quantity of
hot dogs
Price of
hamburgers
Quantity of
hamburgers
2008
2009
2010
$1
$2
$3
100
150
200
$2
$3
$4
50
100
150
Calculating Nominal GDP
2008
2009
2010
($1 per hot dog × 100 hot dogs) + ($2 per hamburger × 50 hamburgers) = $200
($2 per hot dog × 150 hot dogs) + ($3 per hamburger × 100 hamburgers) = $600
($3 per hot dog × 200 hot dogs) + ($4 per hamburger × 150 hamburgers) = $1,200
Calculating Real GDP (base year 2008)
2008
2009
2010
($1 per hot dog × 100 hot dogs) + ($2 per hamburger × 50 hamburgers) = $200
($1 per hot dog × 150 hot dogs) + ($2 per hamburger × 100 hamburgers) = $350
($1 per hot dog × 200 hot dogs) + ($2 per hamburger × 150 hamburgers) = $500
Calculating the GDP Deflator
2008
2009
2010
($200 / $200) × 100 = 100
($600 / $350) × 100 = 171
($1,200 / $500) × 100 = 240
This table shows how to calculate real GDP, nominal GDP,
and the GDP deflator for a hypothetical economy that
produces only hot dogs and hamburgers.
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Real Versus Nominal GDP
• The GDP deflator (all goods and services)
– Measure of the price level for all goods and
services – inflation at the national level
– Ratio of nominal GDP to real GDP times 100
– =100 for the base year
– Measures the current level of prices relative to
the level of prices in the base year
• Inflation
– Economy’s overall price level is rising
15
Real Versus Nominal GDP
• Inflation rate
– Percentage change in some measure of the
price level from one period to the next
GDP deflator in year 2 - GDP deflator in year 1
Inflation in year 2 
 100
GDP deflator in year 1
• The GDP deflator
– Can be used to take inflation out of nominal
GDP (“deflate” nominal GDP)
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Real GDP over recent history
• The GDP data
– Real GDP grows over time
– Growth is not steady
• Recession
– Real GDP declines
– Lower income
– Rising unemployment
– Falling profits
– Increased bankruptcies
17
GNP Growth is Not Steady
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Figure 2
Real GDP in the United States
This figure shows quarterly data on real GDP for the U.S. economy since 1965.
Recessions—periods of falling real GDP—are marked with the shaded vertical bars. 19
The Business Cycle – Another Look
20
Business Cycle - Phases
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GDP - Good Measure of Economic Well-being?
• GDP – “single measure of the economic wellbeing of a society”?
– Measures both economy’s total income and
total expenditure
– Larger GDP correlated with
• Good life
• Better healthcare
• Better educational systems
22
International differences in GDP
and the quality of life
• Rich countries - Higher GDP per person
– Better
• Life expectancy
• Literacy
• Internet usage
• Poor countries - Lower GDP per person
– Worse
• Life expectancy
• Literacy
• Internet usage
23
GDP - Good Measure of Economic Well-being?
• Does not consider how income is distributed
(GINI coefficient)
• A low Gini coefficient indicates a more equal
distribution,
– 0 corresponding to complete equality,
– higher Gini coefficients => more unequal
» 1 corresponding to complete inequality. When used as a
measure of income inequality,
» most unequal society will be one in which a single person
receives 100% of the total income and the remaining people
receive none (G = 1−1/N);
» and the most equal society will be one in which every
person receives the same income (G = 0).
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Relative Income Distribution Rankings
• U.S., Gini coefficient of 0.450, ranks near the extreme
end of the inequality scale
– comparable income inequality: Cameroon,
Madagascar, Rwanda, Uganda, Ecuador.
• China, significantly more equal than the U.S.
with a Gini coefficient of 0.415
•
http://www.theatlantic.com/international/archive/2011/09/map-us-ranks-near-bottom-on-income-inequality/245315/
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26
27
28
Equality of Distribution of Income
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GDP - Good Measure of Economic Well-being?
• GDP – not a perfect measure of well-being
– Besides equality/inequality of distribution of
income
– Also doesn’t include value of
• Leisure
• Quality of the environment
• Almost all activity that takes place outside
markets (some legal, some not!)
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Table
3
GDP and the quality of life
Country
United States
Japan
Germany
Russia
Mexico
Brazil
China
Indonesia
India
Pakistan
Bangladesh
Nigeria
Real GDP per
person (2005)
Life
expectancy
Adult literacy
(% of population)
Internet usage
(% of population)
$41,890
31,267
29,461
10,845
10,751
8,402
6,757
3,843
3,452
2,370
2,053
1,128
78 years
82
79
65
76
72
72
70
64
65
63
47
99%
99
99
99
92
89
91
90
61
50
47
69
63 %
67
45
15
18
19
9
7
3
7
0.3
4
The table shows GDP per person and three other measures of the quality of life for
twelve major countries.
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