Measuring Domestic Output, National Income, and the Price Level
1. Gross domestic product (GDP) is the total market value of all final goods/services
produced within a country in one year. GDP does NOT count in intermediate goods/services,
secondhand goods, financial transactions (e.g. stocks, bonds), transfer payments (e.g. social
security, unemployment insurance), profits/income earned by U.S. companies/individuals
overseas.
2. GDP can be calculated in two ways: the amount spent to purchase this year’s output (i.e.
expenditures approach) or the money income derived from producing this year’s total output
(i.e. incomes approach).
a) expenditures approach: consumption (C) + investment (I) + government (G) + net
exports (Xn)
b) income approach: wages (W) + interest (I) + rent (R) + profit (P)
3. Price indices are used to measure price changes in the economy; they are used to compare
the prices of a given “market basket” of goods/services in one year with the prices of the
same “market basket” in another year. A price index has a base year, and the price level in
that year is given an index number of 100; the price level in all other years is expressed as a
percentage of the price level in the base year:
Price index number = current year prices x 100
base year prices
4. Nominal GDP is expressed in current dollars and is unadjusted for price changes whereas
real GDP deflated or inflated for price-level changes. As a formula:
Real GDP =
nominal GDP_______
price index (in hundredths)
5. Inflation is a rising general level of prices whereas deflation is a falling general level of
prices.
6. The inflation rate is calculated by the consumer price index (CPI) which measures the
prices of a market basket of 300 consumer goods/services purchased by a typical urban
consumer.
Inflation Rate=
CPI2 – CPI 1
CPI 1
x100
7. Nominal income includes wages, interest, rent, and profit received in current dollars whereas
real income measures the amount of goods/services nominal income can buy. As an
equation:
% change in real income = % change in nominal income - % change in price level
8. While inflation reduces the purchasing power of the dollar (i.e. the amount of
goods/services each dollar will buy), it does not necessarily decrease a person’s real income
if nominal income rises with the price level. Unanticipated inflation will hurt the following
groups: those on fixed incomes, savers, and lenders.
9. The nominal interest rate includes the real rate of interest (the % increase in purchasing
power which the borrower pays the lender for the privilege of borrowing) and the expected
rate of inflation. As a formula:
Nominal interest rate = expected rate of inflation + real rate of interest
If the nominal interest rate is 10% based upon an expected rate of inflation of 4%, the real
rate of interest is 6%. If actual inflation is less than 4%, the lender gains and if the actual rate
is greater than 4% the borrower gains purchasing power.
10. Three types of inflation include creeping, galloping, and hyperinflation.