Measuring Domestic Output, National Income, and the Price Level

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
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
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
Inflation Rate=
CPI2 – CPI 1
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
% 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.