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chapter 2 (1)

Chapter 2: Measuring the Macroeconomy
Hikaru Saijo
University of California, Santa Cruz
2.2 Measuring the State of the Economy
• Gross domestic product (GDP):
The market value of the final goods and services
produced in an economy over a certain period
• United States GDP:
• $12.5 trillion in 2005
• $14.4 trillion in 2008 ($47,000 per person)
• $20.5 trillion in 2018 ($62,00 per person)
• Production measure of GDP
The number of goods produced in the economy.
• Expenditure measure
The total purchases in the economy.
• Income measure
All the income earned in the economy.
• All three approaches give identical measures of GDP.
• Thus
• When calculating income, we need to distinguish between
“profits” and “economic profits”
• Profits
Normal competitive return on inputs.
• Economic profits
Above-normal returns associated with prices that exceed
those that prevail under perfect competition.
The Expenditure Approach to GDP
The national income accounting identity states:
Y =
• Y = GDP (in dollars)
• C = consumption
• I = investment
• G = government purchases
• NX = net exports = exports − imports
• Net exports (trade balance) for the United States is
• The recent trade deficit indicates that the United States
is borrowing goods from the rest of the world.
• As the trade balance has turned negative, consumption
has increased as a share of GDP recently.
The Income Approach to GDP
• The income approach
Measures the sum of all income earned in the economy
• Capital
• Inputs into production other than labor that are not
used up in the production process
• Increased by firms through investment
• Depreciation
• The deterioration of the capital stock due to wear and
• GDP −
= net domestic product
• Total shares of GDP to inputs:
• Share of GDP to Labor (labor share):
• Share of GDP to Capital (capital share):
• Labor’s share of GDP has remained approximately
constant over time.
The Production Approach to GDP
• There is no “double counting” in GDP
Only the final sale of goods and services count.
• Value added
• The amount each producer contributes to GDP.
• The revenue generated by each producer minus the value
of intermediate products.
• Only new production of goods and services counts toward
What Is Included in GDP and What’s Not?
• Only goods and services that are transacted through
markets are included in GDP.
• Included:
Government spending on goods/services
Factory production
Healthcare expenditures
Ingredients and food purchased
Kids in day care
• Not included:
Government transfer payments
Environmental conditions
A measure of a nation’s health
Time spent cooking at home
By How Much Does GDP Rise?
A used car dealer buys a car for $5000 and sells it to a
customer for $6000.
A factory in the U.S. purchases a new machine from
Japan for $1 million.
A bookstore that specializes in foreign books buys $2000
worth of books from Germany and sells it to U.S.
consumers for $2500.
2.3 Measuring Changes Over Time
• When examining GDP over time, we need to take into
account changes in prices.
• Nominal GDP:
• A measure of GDP when prices and quantities have not
been separated, using current year prices
• nominal GDP = price level ×
• Real GDP:
• Actual quantity of goods and services, using base year
• real GDP = nominal GDP /
• To compute GDP across time, we must use one year’s
• Real GDP will be measured in a certain year’s dollars.
• Nominal GDP is measured in current dollars.
• Consider Apples and Computers:
nominal GDP = (prices of apples × quantity of apples) +
(prices of computers × quantity of computers)
A Simple Example: Where Real GDP Doesn’t
• If the quantity of goods and services produced does not
change, but prices do change
• Nominal GDP will change.
• Real GDP will not change.
× 500 apples +
× 5 computers = $5, 000
$1, 00
× 500 apples +
× 5 computers = $6, 000
Quantity Indexes: Laspeyres, Paasche, and Chain
• Calculating real GDP changes over time:
• The Laspeyres index
Calculates changes in real GDP using the initial prices.
• The Paasche index
Calculates changes in real GDP using the final year
• Over long-time intervals the two indexes can result in
substantial differences.
• The Fisher index (chain weighting) is the preferred
approach to calculating real GDP.
• Average of the Laspeyres and Paasche index.
• Preferred because new goods are invented while others
become obsolete – making early or recent prices
• Can be applied on a year-by-year basis if we compute
real GDP each year.
Price Indexes and Inflation
• Recall the formula for nominal GDP:
nominal GDP =
• The GDP deflator is the price level that satisfies the
• We could compute this formula for two different years to
calculate a price change.
• We could also use the following math trick:
percentage change in nominal GDP ≈ percentage change
in price level + percentage change in real GDP
• The inflation rate is the percentage change in the price
Using Chain-Weighted Data
• Main reason for using chain-weighted data:
Prices of computers rapidly changed in the 1990s
• Main disadvantage:
The sum of real C , I , G , NX will not equal real
chain-weighted GDP because the prices used in
constructing the components are different.
• General rule to follow:
• For particular components of GDP, we look at the ratio
of nominal variables.
• When you want real rates of economic growth, use the
chain-weighted real measures.
2.4 Comparing Economic Performance across
• The exchange rate:
Price at which different currencies are traded
• To make comparisons of GDP across countries:
• GDP must be expressed in a common currency by first
adjusting it by the exchange rate.
• This value of nominal GDP must be multiplied by the
ratio of prices in the countries.
An Example of Comparisons of Economies
• Suppose we are trying to compare GDP in China and the
United States.
• China’s GDP: 75.2 trillion yuan
• Exchange rate: 6.76 yuan per dollar
• Goods in China, on average, cost about 62.5 percent of
goods in the United States
An Example of Comparisons of Economies
Use the exchange rate to turn Chinese yuan into U.S.
Adjust for relative price level of goods: