ECON2123 (Spring 2012)
15 & 16.2.2012 (Tutorial 2)
Chapter 2: Key Macroeconomics Variables
National income accounting

Gross domestic product (GDP): The market value of all final goods and services
produced in a country during a given period.

Gross national product (GNP):
The market value of all final goods and services
produced by the domestically owned factors of
production during a given period.
Three approaches to calculate GDP
1) Product approach/ Value added approach (Production side)
 The value of final goods and services produced in an economy during a given period
 The sum of value added in the economy during a given period
 Value added: the value of production – value of intermediate goods
 Intermediate good: goods used in the production of other goods in the same period when
they are produced
2) Income approach (Income side)
 The sum of incomes in the economy during a given period
 Labor income/ wages, capital income/ profit, tax to the government, rent, interest income,
dividends…etc
3) Expenditure approach
 We could find out GDP by looking at the expenditures of different sectors
 National income accounts identity: GDP = Y = C + I + G + (EX – IM)
Other remarks:
1) Treatments of intermediate good, capital good, inventory investment, exports and imports
 Capital good: goods used in the production of other goods
 Inventory investment: the difference between production and sales
2)
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Problems of GDP definitions
Non-market transactions are not included. For example, barter.
Positive/ Negative externalities are not included. Quality of goods not considered.
Wealth distribution
Sustainability
Underground economy
Nominal and real GDP
 Real GDP: the values of goods and services measured using a constant set of prices
 Nominal GDP: the value of goods and services measured at current prices
 Real GDP per capita  average standard of living
GDPt  GDPt 1
 GDP growth rate 
100%  economic expansion/ recession
GDPt 1
The level of price and inflation
 Inflation: sustained rise in the general level of prices in the economy
P  Pt 1
 Inflation rate = t
(where Pt is a price index: could be GDP deflator or CPI)
Pt 1
1
GDP deflator
 The ratio of nominal GDP and real GDP
 GDP deflator = Nominal GDP / Real GDP 
Pt  Qt
P
 t
Pbase  Qt Pbase
 Pt /Pbase shows the change in the price level
 Nominal GDP = Real GDP  GDP deflator
 GDP deflator allows us to separate nominal GDP into 2 parts: one part measures
quantities (real GDP) and the other measures prices (GDP deflator)
 Real GDP = Nominal GDP / GDP deflator
 The GDP deflator is used to deflate nominal GDP to yield real GDP
Consumer price index (CPI)
 A measure of the overall price level of prices that shows the cost of a fixed basket of
consumer goods relative to the cost of the same basket in a base year
 Qibase  Picurrent  100
 CPI in current year =
 Qibase  Pibase
Key difference between GDP deflator and CPI
1) GDP deflator measures the prices of all goods and services produced including capital
goods, whereas CPI measures the prices of consumer goods only
2) GDP deflator includes only domestically produced goods, whereas CPI measures both
domestically produced goods and imported goods
3) GDP deflator is computed with a changing basket of goods, whereas CPI is computed
with a fixed basket of goods
The Unemployment Rate
 The households in the working age population will be assigned to one of the three
categories: Employed (E), Unemployed (U) and Not in the labor force (NLF)
 Employment: the number of people who have a job
 Unemployment: the number of who do not have a job but are looking for a job
 NLF: those who do not have a job and are not looking for a job
Labor force (L): it consists of all employed (E) and unemployed workers (U). L  E  U
U
 Unemployment rate (u): the fraction of the labor force that is unemployed. u 
L
 Problems of the definition of unemployment rate:
1) Does not include underemployment
2) Does not include discouraged workers
 Discouraged workers: people without a job who give up looking for work
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
Participation rate: labor force / total population of working age 
E U
E  U  NLF
 Economists care about unemployment because:
 It directly affects the welfare of the unemployed
 It provides a signal that the economy may not be using some of its resources efficiently
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Examples and Problems
Example 1
During a given year, the following activities occur:
Stage 1: Firm 1 produces steel, employing workers and using machines to produce the steel.
It sells the steel for $100 to Firm 2, which produces cars. Firm 1 then pays its
workers$80, leaving $20 in profit to the firm.
Stage 2: Firm 2 buys the steel and uses it, together with workers and machines, to produce
cars. Revenues from car sales are $210. Of the $210, $100 goes to pay for steel and
$70 goes to workers in the firm, leaving $40 in profit to the firm.
a) Using the “production of final goods” approach, what is GDP in this economy?
$210, the value of the car
b) What is the value added at each stage of production? Using the “value added” approach,
what is GDP?
1st stage: $100, 2nd stage: $210 – $100 = $110
GDP = $100 + $ 110 = $ 210
c) What are the total wages and profits earned? Using the income approach, what is GDP?
Wage: $80 + $70 = $150, Profits: $20 + $40 = $60
GDP = $150+ $60 =$210
Example 2
Consider the following economy with 2 firms.
Firm A (produces oranges)
Wages to workers:
Taxes to government:
Revenue from sales:
Unsold oranges at market price:
$15
$5
$45 (sold to public: $10, sold to Firm B: $25, Export:$10)
$10
Firm B (produces orange juice)
Wages to workers:
Taxes to government:
Oranges purchased from Firm A:
Oranges imported from overseas:
Inventory of orange from last year:
Orange left at the end of this year:
Revenue from sales:
$10
$2
$25
$10
$10
$15
$40
Use the 1) product approach (value added), 2) expenditure approach and 3) income approach
to calculate the GDP of the economy
1) Value added approach
Firm A’s value added:
Firm B’s value added:
55 = (45 + 10)
10 = 40 – orange used in producing OJ
[Orange used in producing OJ: (25 + 10 + 10) – 15 = 30]
 GDP = 55 + 10 = 65
o Remark: intermediate goods deducted to avoid double counting
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2) Expenditure approach
Consumption:
50 = (10 + 40)
A’s Inventory investment:
10
B’s Inventory investment:
5 = (15 – 10)
Export:
10
Import:
–10
 GDP = 50 + 10 + 5 + 10 – 10 = 65
o Remark: “+” for inventory investment and exports, and “–“ for imports
3) Income approach
Wages:
25 = (15 + 10)
Firm A’s profit:
35 = (45 – 15 – 5 + 10)
Firm B’s profit:
–2 = (40 – 10 – 25 – 10 + 15 – 10 – 2)
Taxes:
7 = (5+2)
 GDP = 25 + 35 – 2 + 7 = 65
o How are the profits calculated?
Example 3
Consider an economy that produces only 3 types of fruits: apples, oranges, and bananas.
In the base year and current year, the production and price date were as follows:
Base Year
Apples
Bananas
Oranges
Quantity
3000
6000
8000
Price
2
3
4
Current Year
Quantity
Price
4000
3
14000
2
32000
5
a) Find nominal GDP in the current year and in the base year.
GDP in current year: (4000*3) + (14000*2) + (32000* 5) = 200000
GDP in base year: (3000*2) + (6000*3) + (8000* 4) = 56000
b) Find real GDP in current year and in the base year.
Real GDP in base year: 56000
Real GDP in current year: (4000*2) + (14000*3) + (32000* 4) = 178000
c) Find the GDP deflator for the current year and the base year. By what percentage does the
price level change from the base year to the current year?
GDP deflator (Nominal GDP / Real GDP) of base year: 1
GDP deflator of current year: (200000/178000)*100 = 1.12
Percentage change in price level from base year to current year = 12%
Example 4
U.S. working age population by group, June 2006
Number employed = 144.4 million, Number unemployed = 7.0 million
Size of working age population = 228.8 million
Use the above data to calculate
(a) The size of labor force = 144.4M  7M  151.4M
(b) Number of people not in the labor force = 228.8M 151.4M  77.4M
151.4M
(c) Labor force participation rate =
100%  66.2%
228.8M
7M
(d) The unemployment rate =
100%  4.6%
151.4M
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