Measuring GDP and Economic
Growth
Two Ways
of Measuring GDP
• GDP is a measure of both output and
income. Thus, there are two ways it can
be measured.
• GDP can be derived by totaling the
expenditures on final-user goods and services
produced during the year. This is called the
expenditure approach.
• Alternatively, GDP can be calculated by
summing the income payments to the resource
suppliers and the indirect cost of producing
the goods and services. This is called the
income approach.
Expenditure Approach
• Expenditure Approach:
• GDP is the sum of expenditures on final-user
goods and services purchased by households,
investors, governments, and foreigners.
• When calculated by this method, there are
four components of GDP:
• personal consumption purchases “C”
• gross private investment “I”
(including inventories)
• government purchases “G”
(consumption and investment)
• net exports (exports minus imports) “Nx”
Income Approach
• GDP is the sum of costs incurred and income
(including profits) generated by the production
of goods and services during the period.
• The direct cost income components of GDP:
• employee compensation
• self-employment income
• rents
• interest
• corporate profits
The SUM of these measurements is called:
National Income
Making Expenditures and Income
Equal
We add back to National Income:
• Indirect business taxes:
Taxes that increase the firm’s production
costs and therefore final prices.
• Depreciation:
The cost of wear and tear on the machines
and other capital assets used to produce
goods and services.
• Net Income of Foreigners:
The income that foreigners earn producing
goods within the borders of the U.S. minus
the income Americans earn abroad.
Real and Nominal GDP
• The term "real" means adjusted for
inflation.
• Price indexes are use to adjust income
and output data for the effects of
inflation.
• A price index measures the cost of purchasing
a market basket (or “bundle”) of goods at a point
in time relative to the cost of purchasing the
same market basket during an earlier
reference (or base) period.
Key Price Indexes
• 1. Consumer Price Index
An established “market basket” of typical goods and
services is periodically measured to track changes
in prices. This measurement becomes known as the
“Price Level.” (PL) (more on this one later)
• 2. GDP Deflator
Measures changes in the average price of the
market basket of goods included in all of GDP.
The GDP deflator is a broader price index
than the CPI.
Using an Index
Inflation Rate =
this year’s index – last year’s index
X 100
last year’s index
Real GDP Per Capita
• aka “Per Capita Output”
• Formula:
– Real GDP ÷ Population
– Per Capita GDP is an important measure of
Standard of Living (SoL)
– Note that this formula acts as a ratio:
nations can increase SoL by increasing Real
GDP or by reducing the rate of population
growth relative to Real GDP
Rule of 70
• The Rule of 70 is a “doubling rule.” It allows us
to determine, given a constant rate of growth,
how long it will take any variable to double.
• It is statistically useful but not mathematically
precise.
• To use, divide the percentage rate of growth into
70. The result is the amount of time it will take
to double the variable.
• e.g., If a population grows at a rate of 2 percent
per year, how long will it take that population to
double in size?
The Business Cycle
Business Cycle Recovery
How Do Know Where We Are in the
Business Cycle?
• Economic Indicators
– Leading: Tend to predict economic trends. These
indicators change before the business cycle changes.
e.g., stock market decline, new orders for consumer
/capital goods, initial claims for unemployment, building
permits for houses
– Coincident: Occur alongside the trend. e.g., retail sales,
current GDP and Personal Income
– Lagging: Follows changes that have already occurred in
the economy. e.g., unemployment, official declaration of
recession (two consecutive negative quarters of GDP)
Which Areas Are Most Affected by
Recession?
• Investment: During a recession, business
are reluctant to purchase equipment,
expand factories and build new homes. Net
investment can even be negative, as firms
“make do” with old capital.
• Capital /Durable Goods: Firms and
households put off large purchases.
• Service/nondurable goods: Necessities
tend to survive recessions with less
downturn.
Unemployment
• I. Measuring Unemployment
– Unemployment Rate =
unemployed
civilian labor force
X 100
Who is not counted in the unemployment numbers:
people who have given up (discouraged worker)
people not in labor force by choice
In addition, we count someone who is employed part-time as
being employed, thus the official unemployment
percentage probably understates unemployment.
January 2010 Official Unemployment: 10 percent
“Real Unemployment” Likely closer to 17 percent
II. Unemployment by Educational
Attainment
December 2010 Bureau of Labor Statistics
•
•
•
•
High School dropout:
15.3 percent
High School diploma only:
9.8 percent
Some college /associate’s degree:
8.1 percent
Bachelor’s or higher
4.8 percent
• Teenage (16-19)
25 percent
III. Types of Unemployment
• Cyclical: Moves with the Business Cycle;
most recessionary unemployment is cyclical
and mostly returns with expansion.
• Frictional: Movement from one job to
another; unemployment by choice
• Structural: Permanent job loss; as skills
become outdated, outsourced or replaced
by technology.