Prepared by:
Fernando & Yvonn Quijano
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With accurate economic data,
Portugal was able to make the
transition from revolution in 1975 to
a prosperous democracy today.
What you will learn in
this chapter:
➤ How economists use aggregate
measures to track the performance of
the economy
➤ What gross domestic product, or
GDP, is and the three ways of
calculating it
➤ The difference between real GDP and
nominal GDP and why real GDP is the
appropriate measure of real economic
activity
➤ The significance of the unemployment
rate and how it moves over the
business cycle
➤ What a price index is and how it is
used to calculate the inflation rate
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The National Accounts
The national income and product
accounts, or national accounts, keep
track of the flows of money between
different sectors of the economy.
“In fact, the accuracy of a
country’s accounts is a remarkably
reliable indicator of its state of
economic development.”
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The National Accounts
The Circular-Flow Diagram, Revisited and Expanded
Consumer spending is household
spending on goods and services.
A stock is a share in the ownership of a
company held by a shareholder.
A bond is borrowing in the form of an
IOU that pays interest.
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The National Accounts
The Circular-Flow Diagram, Revisited and Expanded
Government transfers are payments by the
government to individuals for which no good or service is
provided in return.
Disposable income, equal to income plus government
transfers minus taxes, is the total amount of household
income available to spend on consumption and to save.
Private savings, equal to disposable income minus
consumer spending, is disposable income that is not
spent on consumption.
The banking, stock, and bond markets, which channel
private savings and foreign lending into investment
spending, government borrowing, and foreign borrowing
are known as the financial markets.
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The National Accounts
The Circular-Flow Diagram, Revisited and Expanded
Government borrowing is the amount of
funds borrowed by the government in the
financial markets.
Government purchases of goods and
services are government expenditures on
goods and services.
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The National Accounts
The Circular-Flow Diagram, Revisited and Expanded
Goods and services sold to residents of
other countries are exports; goods and
services purchased from residents of other
countries are imports.
Investment spending is spending on
productive physical capital, such as
machinery and construction of structures,
and on changes to inventories.
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Consumer spending is household
spending on goods and services.
A stock is a share in the ownership of a
company held by a shareholder.
A bond is borrowing in the form of an IOU
that pays interest.
Government borrowing is the amount of
funds borrowed by the government in the
financial markets.
Government purchases of goods and
services are government expenditures on
goods and services.
Government transfers are payments by the
government to individuals for which no good or
Goods and services sold to residents of other
service is provided in return.
countries are exports; goods and services
purchased from residents of other countries
Disposable income, equal to income plus
are imports.
government transfers minus taxes, is the total
amount of household income available to spend
on consumption and to save.
Private savings, equal to disposable income
minus consumer spending, is disposable
income that is not spent on consumption.
Investment spending is spending on
productive physical capital, such as
machinery and construction of structures,
and on changes to inventories.
The banking, stock, and bond markets, which
channel private savings and foreign lending into
investment spending, government borrowing,
and foreign borrowing are known as the
financial markets.
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HW
p. 391 #2
p. 392 #5
• Coca-Cola invests
• Delta sells used plane
• Moneybags buys stock
• Wine exported
• Perfume imported
• Publisher
adds
books
toof inventory
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Publishers
Essentials
Economics Krugman • Wells • Olney
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What GDP does NOT count?
Public transfer payments
Social Security, welfare
Private transfer payments
$100 from Grampa
Stock market transactions
You purchased 200 shares of Microsoft –
not counted
BUT! The services of the stockbroker are
counted.
Secondhand sales
Used cars, clothing
© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney
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The National Accounts
Gross Domestic Product
Final goods and services are goods and services
sold to the final, or end, user.
Intermediate goods and services are goods and
services—bought from one firm by another firm—
that are inputs for production of final goods and
services.
Gross domestic product, or GDP, is the total
value of all final goods and services produced in
the economy during a given year.
Aggregate spending, the sum of consumer
spending, investment spending, government
purchases, and exports minus imports, is the total
spending on domestically produced final goods and
services in the economy.
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2 most common ways GDP is measured
Expenditures, Income
Expenditures Approach
- Measures GDP in terms of all of the money that
was spent on buying it.
Income Approach
- Measures GDP in terms of all of the incomes
that were derived in producing it.
C +Ig + G + Xn = Wages + Rents + Interest + Profits
© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney
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3 ways of Calculating GDP
“Government statisticians use all three methods”
Hypothetical economy has 3 firms
•
•
•
American Motors, Inc – produces 1 car/year
American Steel, Inc – produces steel for car
American Ore, Inc – produces iron ore for steel
This economy produces 1 car worth $21,500.
So, GDP = ?
But, let’s look at 3 ways of getting to that # so that we
can do it for more complex economies.
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The National Accounts
Calculating GDP
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2.
3.
1.
© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney
Calculating
GDP
3 Ways (Expert Groups p. 372-5)
chapter
1. Measuring
GDP as the
Value of
Production of
Final Goods
and Services
2. Measuring
GDP as
Spending on
Domestically
Produced Final
Goods and
Services
3. Measuring
GDP as Factor
Income Earned
from Firms in
the Economy
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The National Accounts
Calculating GDP
Measuring GDP as the Value of Production of Final
Goods and Services
The value added of a producer is the value
of its sales minus the value of its purchases
of inputs.
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The National Accounts
Calculating GDP
Measuring GDP as Spending on Domestically
Produced Final Goods and Services
Another way to calculate GDP is by adding
up aggregate spending on domestically
produced final goods and services. That is,
GDP can be measured by the flow of funds
into firms.
The following equation breaks GDP down
by the four sources of aggregate spending:
C = Consumer spending
I = Investment spending
(15-1)
GDP = C + I + G + X - IM
G = government purchases
X = exports
IM = Imports
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The National Accounts
Calculating GDP
Measuring GDP as Factor Income Earned from
Firms in the Economy
Another way to calculate GDP is to add up
all the income earned by factors of
production from firms in the economy—the
wages earned by labor; the interest earned
by those who lend their savings to firms and
the government; the rent earned by those
who lease their land or structures to firms;
and the profit earned by the shareholders,
the owners of the firms’ physical capital.
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p392 #4
4.
a.
b.
c.
Different ways of getting to $275
Value Added
Final Goods
Factor Income
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P. 377 #1
Revise your answers now if need be.
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The National Accounts
Calculating GDP
The Components of GDP
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The National Accounts
Calculating GDP
The Components of GDP
Net exports are the difference between the
value of exports and the value of imports.
What GDP Tells Us
The most important use of GDP is as a
measure of the size of the economy,
providing us a scale against which to
measure the economic performance of other
years, or compare the economic performance
of other countries.
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Nominal GDP – to show comparison among nations
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)
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Real GDP – to show change over time
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Real GDP and Aggregate Output
Calculating Real GDP
Real GDP is the total value of all final goods
and services produced in the economy
during a given year, calculated using the
prices of a selected base year.
Nominal GDP is the value of all final goods
and services produced in the economy
during a given year, calculated using the
prices current in the year in which the output
is produced.
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Real GDP and Aggregate Output
Calculating Real GDP with 2 products…
TABLE 15-1
Calculating GDP and Real GDP in a Simple Economy
Year 1
Year 2
Quantity of apples (billions)
2,000
2,200
Price of apple
$0.25
$0.30
Quantity of oranges (billions)
1,000
1,200
Price of orange
$0.50
$0.70
GDP (billions of dollars)
$1,000
$1,500
Real GDP (billions of year 1 dollars)
$1,000
$1,150
Year 1
Year 2
Nominal
2000x.25 + 1000x.50 = 1,000B
2200x.30 + 1200x.70 = 1,500B
Real
Same
2200x.25 + 1200x.50 = 1,150B
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p. 392 #6 Economy of Britannica with 3 goods
% change = (current - initial)/ initial X 100
a. % change in production
b. % change in prices
c. Nominal GDP; % change in nominal
d. Real GDP; % change in Real
Computers
Year
P
Q
DVD’s
Pizza
P
Q
P
Q
%cha
Prod
%cha
price
C D P
C DP
‘02
900
10
10
100
15
2
‘03
1000
10.5
12
105
16
2
‘04
1050
12
14
110
17
3
Nom
GDP
%cha
nom
------
© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney
Real
GDP
%cha
real
------
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Real GDP and Aggregate Output
Calculating Real GDP with 2000 as base year
TABLE 15-2
Nominal versus Real GDP in 1996, 2000, and 2004
Nominal GDP (billions of
current dollars)
Real GDP (billions of
2000 dollars)
1996
$7,817
$8,329
2000
9,817
9,817
2004
11,734
10,842
Why is Real GDP in 1996 higher than nominal?
Why is Real GDP in 2004 lower than Nominal?
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p. 392 #7
a. Why is Real GDP greater than nominal in
situations when we are comparing previous
years to more current years?
b. (current – initial) / initial X 100
c. Real GDP / population (do division and move
decimal to the right 5 places)
d. (current – initial) / initial X 100
e. % change in real GDP vs % change in GDP per
capita
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Real GDP and Aggregate Output
What Real GDP Doesn’t Measure
GDP per capita is GDP divided by the size
of the population; it is equivalent to the
average GDP per person.
http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)_per_capita
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Read “What Real GDP Doesn’t Measure” p.379
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Human Development Index (HDI)
Dark Green-Green-Light Green Yellow-Light Orange-Orange-Red-Brick-Black
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Infant Mortality Rates
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Literacy Rates
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Life Expectancy
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Carbon Dioxide Emissions
chapter
(metric tons)
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Carbon-dioxide emissions
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If you are interested in sustainable economics…
http://www.neweconomics.org/
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Unemployment
http://www.bls.gov/
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Job sites
http://www.monster.com
http://www.craigslist.com
http://www.careerbuilder.com/
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What is the relationship between unemployment and GDP growth?
Does GDP growth always mean a positive employment growth?
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The Unemployment Rate
Growth and Unemployment
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© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney
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The Unemployment Rate
Understanding the Unemployment Rate
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Wednesday 4/6/2011
Today
• Price Indexes and the CPI
HW for tonight
• Bring in Questions for tomorrow’s review session
• Quiz - Friday
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Price Indexes and the Aggregate Price Level
Market Baskets and Price Indexes
A market basket is a hypothetical set of
consumer purchases of goods and services.
TABLE 15-3
Calculating the Cost of a Market Basket
“Florida citrus frost
increases prices”
Pre-frost
Post-frost
Price of orange
$0.20
$0.40
Price of grapefruit
$0.60
$1.00
Price of lemon
$0.25
$0.45
Cost of market basket
(200 oranges, 50 grapefruit,
100 lemons)
(200 × $0.20) +
(50 × $0.60) +
(100 × $0.25) = $95.00
(200 × $0.40) +
(50 × $1.00) +
(100 × $0.45) = $175.00
$175/$95 = 1.842 = 84.2%. So “the average price of a post-frost basket of
FL citrus fruits is 84.2% higher than the pre-frost basket.”
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Quick practice
Market basket for 100 homes in Coral Gables in 2000 =
$400,000
Market basket for 100 homes in Coral Gables in 2010 =
$600,000
What was the percent change in homes prices from
year 2000 to 2010?
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Price Indexes and the Aggregate Price Level
Market Baskets and Price Indexes
A price index measures the cost of
purchasing a given market basket in a given
year, where that cost is normalized so that it
is equal to 100 in the selected base year.
(15-2) Price index in a given year 
Cost of market basket in a given year
x 100
Cost of market basket in base year
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Practice. Page 393 #11
3 English books
2 math books
4 economics books
2002
2003
2004
Costs
Price Index
English 50
55
57
Math
70
72
74
Econ
80
90
100
2002
2003
English 50
Math
Econ
% change
2004
Costs
Price Index % change
55
57
610
100
14%
70
72
74
669
109.7
5.7%
80
90
100
719
117.9
25%
(e. inflation = 17.9%)
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Price Indexes and the Aggregate Price Level
Market Baskets and Price Indexes
The inflation rate is the percent change per
year in a price index—typically the
consumer price index.
(15-3) Inflation rate 
Price index in year 2 - Price index in year 1
x 100
Price index in year 1
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World Inflation Rates - 2007
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Price Indexes and the Aggregate Price Level
The Consumer Price Index
The consumer price index, or CPI,
measures the cost of the market basket of a
typical urban American family.
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Price Indexes and the Aggregate Price Level
The Consumer Price Index
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1982-4 = 100
© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney
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Price Indexes and the Aggregate Price Level
The Consumer Price Index
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Price Indexes and the Aggregate Price Level
Other Price Measures
The producer price index, or PPI,
measures changes in the prices of goods
purchased by producers.
“Wholesale price
index”
“Early warning
signal”
The GDP deflator for a given year is 100
times the ratio of nominal GDP to real GDP
in that year.
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Price Indexes and the Aggregate Price Level
Other Price Measures
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© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney
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KEY TERMS
National income and product
accounts (national accounts)
Consumer spending
Stock
Bond
Government transfers
Disposable income
Private savings
Financial markets
Government borrowing
Government purchases of goods
and services
Exports
Imports
Investment spending
Final goods and services
Intermediate goods and services
Gross domestic product (GDP)
Aggregate spending
Value added
Net exports
Real GDP
Nominal GDP
GDP per capita
Market basket
Price index
Inflation rate
Consumer price index (CPI)
Producer price index (PPI)
GDP deflator
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economics in action
Good Decades, Bad Decades
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© 2007 Worth Publishers Essentials of Economics Krugman • Wells • Olney