Chapter 7:
Output and Income
Copyright 2011 Worth Publishers, all rights reserved
WHAT YOU
SHOULD HAVE
LEARNED
FROM THE
CHAPTER
• Gross Domestic Product
• What GDP measures
• GDP Approaches
• Real GDP
• Potential GDP
7.1 Aggregate Output and
Income
• Gross Domestic Product
– Most widely used measure of a nation’s aggregate output
– GDP is a dollar measure- it measures income and the
dollar value of output: money spent on goods and
services produced in the economy
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7.1 Aggregate Output and
Income
• National Income Accounting
– Chain of production
– Wheat Farmer Old Time Mill Flour Co.  Mound City
Doughnut Shoppe
– Economic aggregate output = 200. Only the final amount of
revenue earned from final good (doughnut)
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7.1 Aggregate Output and
Income
• Intermediate Good
– Something that is used in the production of another good
• The price paid for the final good includes all the costs
incurred up to the point of selling that final good
• The value of the final goods is equal to the sales
revenue earned from them. The revenue is
distributed as income to workers and profits
• The value of output matches income earned (true for
each stage of the production process)
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Try It Now Problem
• In each of the following instances, is the good an
intermediate or final good?
– Sugar purchased by a baker to make cupcakes
– Sugar purchased by an individual to make cupcakes
– Dresses purchased at Target
– Tomatoes bought by an Italian restaurant
– Tires bought by a car manufacturing factory
– Iris buys a dozen roses for her mother's birthday
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7.1 Aggregate Output and
Income
• Value Added
– The increase in market value of an item as it progresses
through stages of production.
• Value added at each stage of the production process
– Farmer= $40 (turned nothing into wheat) [40-0=40]
– Miller= $60 (takes $40 worth of wheat and turns it into
$100 worth of flour) [100-40=60]
– Baker= $100 (takes $100 worth of flour and turns it into
$200 worth of doughnuts) [200-100=100]
• The sum of value is reflected in the final price of the
good
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7.1 Aggregate Output and
Income
• Gross Domestic Product (GDP)
– The market value of all final goods and services produced
in an economy during a given period of time.
• The market value of all final goods and services…
– Only final goods: if we count intermediate goods this
would double count them in the value of production
– Market value: only legal final goods and services (nonmarket transactions are not included). Therefore GDP
excludes;
 the value of transactions occur in illegal/underground/shadow
markets
 The value of unpaid services you provide around your house
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7.1 Aggregate Output and
Income
• Gross Domestic Product (GDP)
– The market value of all final goods and services produced
in an economy during a given period of time.
• …produced in an economy…
– Non earned income is ignored
 Examples: Social Security check, payments to welfare recipients
– Produced here, no matter where the product is sold and
no matter who is producing it
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7.1 Aggregate Output and
Income
• Gross Domestic Product (GDP)
– The market value of all final goods and services produced
in an economy during a given period of time.
• …in a given period of time.
– The value of current production and income
 Items produced in previous periods (say in 1998) and sold in
current year (say in 2014) are not included in the GDP for current
year (i.e. 2014)
– Any good produced and purchased in a previous year, no
matter how valuable is not counted in the current GDP
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7.2 Should We Measure
Production or Income?
• Final Goods Approach
– Measuring GDP based on adding up the dollar value of the
final goods and services sold in the economy in the
current time period
• The Final Goods Approach- finding the nation’s GDP
by adding up the dollar value of the final goods and
services sold in the economy
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7.2 Should We Measure
Production or Income?
• Four Sectors
– Households: Consumers (consumption)- spending on goods and
services no matter the origin
– Business: For and non profit business (investment)- spending
on goods to produce other goods
– Government: state, local and national purchases of goods and
services
– The rest of the world: international trade (net exports)- goods
and services produced here and sold abroad (exports) AND
goods produced abroad and purchased here (imports)
• Y = C + I + G + (X-M)
– GDP is the sum of the four sectors (different domestic
expenditures made in the economy)
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7.2 Should We Measure
Production or Income?
• Net Exports
– Trade surplus: X>M the value of net exports is positive
– Trade deficit: X<M the value of net exports is negative
• The market value of goods imported and exported is
what is used (not amount)
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7.2 Should We Measure
Production or Income?
• Income Approach
– Measuring GDP adds up all of the incomes earned from people
and businesses producing and selling goods and services
• Indirect taxes: taxes levied by city and or state
• Depreciation: amount needed to repair worn out
machines
• Revenue= Wages + Interest Payments + Cost of Inputs +
Indirect Business Taxes + Depreciation + Profits
– C+I+G+X-M=Y
– The dollar value of aggregate output equals the dollar value of
aggregate income
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7.2 Should We Measure
Production or Income?
• GDP measures the value of the final goods and
services produced and sold in a given period BUT
ALSO represents the aggregate income generated by
that production
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7.3 Is GDP a Good Measure of
Well-Being?
• GDP values production (output) at current market
value
• Not a perfect measure of economic well being
– It allows us to view the number of goods and services
available for consumers to purchase and enjoy (having
more goods is preferred to fewer)
• GDP understates the true economic value of all
production in the economy
– Quality of life is not included
– Happiness factors- health, marital status, age, crime &
corruption
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7.3 Is GDP a Good Measure of
Well-Being?
• GDP across time or countries does not compare
intangibles (lesser crime, pollution, better health)
– Senator Robert F. Kennedy (1968) a measure such as GDP
“does not include the beauty of out poetry or the strength
of our marriages; the intelligence of our public debate or
the integrity of our public officials…”
• GDP per Capita
– The value of GDP per person. This measures a nation’s
GDP proportional to the size of its population
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7.3 Is GDP a Good Measure of
Well-Being?
• Income levels of countries (GDP of economy)
– There is a strong relationship between having a high standard
of living (GDP per capita) and non economic aspects of life
– Literary rates, access to health care, life expectancy, cleaner
air, political and economic freedom
– Consider how GDP is distributed across population; adjust
GDP by the size of a country’s population
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Try It Now Problem
• Who do you think is the happiest in Charles Dickens’s
A Christmas Carol?
• A: Tom Cratchet
• B: Ebenezer Scrooge
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Try It Now Problem
• Who do you think is the happiest in Charles Dickens’s
A Christmas Carol?
• Answers will vary depending on factors that are not
necessarily included in the GDP.
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7.4 Nominal versus Real GDP
• Overall price level is necessary if you want to see how
purchasing power ha changed over time.
• Prices rise faster than wages, your ability to purchase
the same basket has diminished (purchasing power is
falling), price level changes need to be included when
we measure GDP
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7.4 Nominal versus Real GDP
• GDP is the aggregation of final goods and services
sold at their market prices during a certain period of
time.
– To compare between different years, based solely on GDP,
the distinction must be made between the change in GDP
stemming from changes in price, changes from the final
numbers of goods and services sold, or some combination
of the two
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7.4 Nominal versus Real GDP
• Real GDP
– Calculated by adjusting nominal GDP for changes in the
price level
• Real GDP = (Nominal GDP/Price Index) X 100
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7.4 Nominal versus Real GDP
• Real and Nominal GDP in US
– Nominal GDP: measured in current dollars
– Real GDP: Measured in 2005 $
– Increase in price level (inflation) deflated real GDP relative to
nominal GDP since 2005
– The economy continues to increase production of goods and
services but not as fast as nominal GDP suggests
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7.4 Nominal versus Real GDP
• Growth Rates of Real and Nominal GDP
– Inflation affects comparisons of economic output over time
– The higher the rate of inflation, the growth rate of the nominal GDP
• Real GDP gives a better (more reliable) measure of how many
goods and services are available today compared to the past
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7.5 Real GDP or Potential
GDP
• How close is an economy to its potential GDP?
– Is it underperforming?
• PPF for Food and Movies
– A: all resources devoted to food
production
– B: all resources devoted to movie
production
– Allocation of resources to combination
of movies and food will determine
where and how much is produced at
full capacity (will be on PPF – along
curve)
– C: not at full capacity (potential)- inside
PPF. Actual output of both food and
movies are less than what it could be
– D: economy producing more than its
potential (outside PPF)
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7.5 Real GDP or Potential
GDP
• Potential GDP
– An estimate of what real GDP would be if the economy were
operating at full production
• Real and Potential GDP in US
– Real GDP is above potential when the economy operates above its full
employment
– Real GDP is below potential when the economy was not producing as
many goods and services as it could at full employment level
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7.5 Real GDP or Potential
GDP
• Fluctuations occur around potential GDP, the economy tends
to return to the potential after downturns and expansions
• Growth Rates of Real and Potential GDP
– During recessions, firms need fewer workers (labor) to produce lesser
demand thus machinery (capital) is also idle
– General unemployment of resources- shown when Real GDP dips far
below potential GDP
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7.6 Does Real GDP Grow at
the Same Rate Across
Countries?
• Real GDP Growth Rates: Selected Countries
– Canada, UK and US closely related patterns
– China- fast growth
– Japan- slow growth
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• Intermediate good: Something that is used in the
production of another good
• Value added: The increase in market value of an item
as it progresses through stages of production
• Gross Domestic Product (GDP): The market value of
all final goods and services produced in an economy
during a given period of time
• Final goods approach: Measuring GDP based on
adding up the dollar value of the final goods and
services sold in the economy in the current time
period
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• Income approach: Measuring GDP adds up all of the
incomes earned from people and businesses
producing and selling goods and services
• GDP per capita (per person): The value of GDP per
person. This measures a nation’s GDP proportional
to the size of its population
• Real GDP: Calculated by adjusting nominal GDP for
changes in the price level
• Potential GDP: An estimate of what real GDP would
be if the economy were operating at full production
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• Gross Domestic Product (GDP) is a widely accepted
measure of an economy’s output and income
• What measures the market value of final goods and
services provided in an economy during a given period of
time
• GDP can be measured using the final goods approach or
income approach
• Real GDP is the nominal GDP adjusted for price level
changes
• Potential GDP is a hypothetical measure of what real GDP
would be if the economy were operating at its full
capacity
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