MACROECONOMICS
By
Dr. Nimantha Manamperi
Chapter 7
GDP : Gross Domestic Product
WHAT YOU
WILL LEARN
IN THIS
CHAPTER
• How economists use aggregate
measures to track the performance of
the economy.
• The Gross Domestic Product (GDP)
• Three Ways of calculating GDP.
• The difference between real GDP and
nominal GDP and why real GDP is the
appropriate measure of real economic
activity.
• What are some shortcomings of GDP
calculations?
An Expanded Circular-Flow Diagram
Government purchases of
goods and services
Government borrowing
Government
Consumer
spending
Government
transfers
Taxes
Private savings
Households
Wages, profit,
interest, rent
Factor Markets
Wages, profit,
interest, rent
GDP
Investment
Firms
Borrowing and stock
issues by firms
Foreign borrowing
and sales of stock
Exports
Rest of the world
Imports
Foreign lending and
purchases of stock
Financial Markets
Terms to Know …
• Households earn income via the factor markets from wages,
interest on bonds, dividends on stocks, and rent on land.
• 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.
• In addition, households receive government transfers from
the government. (Social security benefits, Medicaid, etc…)
• Disposable income, total household income minus taxes, is
available to spend on consumption or to save.
Terms to Know …
• Inventories are stocks of goods and raw materials held to
facilitate business operations.
• Investment spending is spending on productive physical
capital, such as machinery and construction of structures,
and on changes to inventories.
• Final goods and services are goods and services sold to the
final, or end, users.
• 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.
E.g.
Terms to Know …
• Private savings, equal to disposable income minus consumer
spending, is disposable income that is not spent on
consumption.
• Government purchases of goods and services (G) is paid for
by tax receipts, as well as by government borrowing.
• Exports (X) generate an inflow of funds into the country
from the rest of the world, while Imports (M) lead to an
outflow of funds to the rest of the world.
Gross Domestic Product
• Gross domestic product or GDP :
The market value of all the final goods and
services produced in a country in a given
period of time.
Gross Domestic Product
• Market Value:
The value of the final goods and services in the market
• Final Goods and Services:
The goods and services are sold to final consumers.
• In a given country
If we calculate the GDP of the United States, then we should
only count the goods and services produced in the united states.
Gross Domestic Product
• In a given period of time
If we calculate the GDP for year 2012, Then we should only
consider the Final goods and services produced in year 2012.
Eg. Calculate the GDP for United States in 2012 given the
following economic transactions.
1. Toyota manufacturer in Alabama produced a 2012 Toyota
Yaris for $20000 and sold in Texas at that price to Mr. Taylor for
private use.
2. Mr. X sold his 2008 produced Nissan Altima through a
dealer for $8000 to Mr. Y in Berea. Dealer fees were $200.
Uses of GDP Data
• Measuring the Living Standards of a Country.
Uses of GDP Data
• Measuring Economic Growth.
• Measuring Business Cycles.
Important Relationship ….
• Aggregate Expenditure : the sum of all the spending in the
economy.
• Aggregate Income : The sum of all the income earned by
the factors of production.
Aggregate Income = Aggregate Expenditure
Aggregate Expenditure = GDP
So,
Aggregate Income = Aggregate Expenditure = GDP
Calculating Gross Domestic Product
• GDP can be calculated three ways:
(1). Counting Market Values.
(2). Adding Up all the Spending on domestically produced
goods and services. (Expenditure Method)
(3). Adding Up the total factor income given to households.
(Income Method)
Market Value Method:
• Country A produces 200 Apples at $1 market price and 100 Oranges for
$3 market price and both will be sold to final consumers . Calculate the
GDP for country A.
• Country B produces $100 worth of milk which will be used in $300 Ice
cream production. Ice creams will be consumed by the school children.
Also country B produces $900 worth clothing. Calculate the GDP for
Country B.
Expenditure Method
• Add all the expenditures on domestic produced goods by;
 Consumers > Consumption ( C )
 Durable Goods
 Non – Durable Goods
 Services
 Firms > Investment ( I )
 Investment Spending
 Government ( G )
 Federal Government
 State and Local
 Rest of the World > Net Exports ( NX )
 Net Exports ( i.e. Exports – Imports)
GDP = C + I + G + NX
Income Method
• Add all the income received by the factors of Domestic
Production;




Wages for labor
Interest Payments received for Capital
Rent Income received for Land
Profits for Entrepreneurship. Etc …..
Calculating Gross Domestic Product
Real versus Nominal GDP
• Real GDP is the total value of the 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.
Real versus Nominal GDP
Calculating GDP and Real GDP in a Simple Economy
Real GDP Vs. Nominal GDP
Real GDP t = ( Nominal GDP t / Price Level t ) * 100
Shortcomings of GDP Data
GDP does not count all the goods and services produced
in an economy.
• Non market Goods and Services : Doing Dishes at
home, Doing your laundry, Washing your Car ,
Making a burger for lunch ….
• Underground Economy : Black Market activities
• Quality of the Environment : A clean environment is
not counted in GDP.
• Leisure Time : The value of the leisure time is not
counted.
Price Indexes and the Aggregate Price Level
• The aggregate price level is a measure of the overall level of
prices in the economy.
• To measure the aggregate price level, economists calculate
the cost of purchasing a market basket.
• A price index is the ratio of the current cost of that market
basket to the cost in a base year, multiplied by 100.
• The consumer price index measures the cost of the market
basket of a typical urban American family.
Market Baskets and Price Indexes
Calculating Price Index in a Simple Economy
Inflation Rate, CPI, and other Indexes
• The inflation rate is the yearly percentage change in a price
index, typically based on the Consumer Price Index, or CPI,
the most common measure of the aggregate price level.
Inflation Rate, CPI, and other Indexes
• Producer Price Index (PPI) :
Measures the changes in the prices of goods purchased
by the producers. (i.e. Coal, Steel, electricity, raw
materials etc …)
• GDP Deflator :
GDP Deflator = ( Nominal GDP / Real GDP ) * 100
Measures of Inflation: Trend