Measuring the State of the Economy
 Gross domestic product (GDP) is the market value of the
final goods and services (g&s) produced in an economy
over a certain period: Consumer g&s (C); Capital goods (I);
G&S the gov’t buys (G); G&S foreigners buy (Ex); but
subtract the imports (Im) that went into C+I+G+Ex
Y = C + I + G + Ex – Im = C + I + G + NX
 U.S. $GDP (=$Y) was 14.6 trillion dollars in 2010.
 Adjusted for inflation since 2005,
Real GDP (= Y) was 13.2 trillion “2005 dollars”
Y = Production = Income = Expenditure
Y = Domestic Production = C + I + G +Ex - Im
Y = Income earned from production
Y = Expenditure of Income on C + I + G + NX
Y = Production = Expenditure = Income
 The production measure of GDP counts the goods
and services produced in the economy.
Y = C + I + G + Ex – Im
 The expenditure measure of GDP counts the total
purchases in the economy.
Y = C + I + G + Ex – Im
 The income measure of GDP counts all the income
earned in the economy from producing Y.
C + I + G + Ex – Im = Y
The Expenditure Approach to GDP
 The national income accounting identity states that Y = C + I + G + NX where Y is
GDP, C is consumption, I is investment, G is government purchases, and NX is net
exports.
 Consumption accounted for 70 % of 2005 US GDP; C includes new autos, food,
clothing, housing services, medical care, travel, entertainment, etc.
 Investment made up 16 % of GDP; I includes business purchases of new plant and
equipment, production of new homes that provide housing services over time, and
increases in business inventories (working capital).
 Government purchases were 19 % of GDP; G includes purchases of goods, e.g.,
missiles, and services, e.g., teacher services, by federal, state, & local gov’ts.
 Transfers are government payments to individuals not associated with any current
production (Social Security, Medicare, unemployment insurance) and are not include in
GDP because no goods are produced.
 C + I + G = 105.8 % of Y = 105.8 % of what the US economy produced
 Net exports are exports minus imports; NX were - 5.8 % of GDP.
 The US is borrowing goods from the rest of the world.
 As the trade balance turned more negative in the early 2000s, consumption increased as
a share of GDP.
Composition of GDP, 2005
2010III
%
100.0
71.0
Durabl 7.5
NonD 15.8
Service 47.1
12.9
3.3
7.4
2.2
20.5
5.6
-3.1
13.2
16.3
CHAPTER 2 Measuring the Macroeconomy
CHAPTER 2 Measuring the Macroeconomy
Income Approach to GDP, 2005
NI = National Income = Income earned from production
Capital income = Y - (Wages + Benefits) - Indirect business taxes - depreciation
NI = Labor income + Capital income = Y - Indirect business taxes - depreciation
Labor income ≈ 2/3 of Y
CHAPTER 2 Measuring the Macroeconomy
CHAPTER 2 Measuring the Macroeconomy
The Production Approach to GDP
 There is no “double counting” in GDP; only the final
sale of goods and services count.
 The amount each producer contributes to GDP is
called the value added.
 Value added is the revenue generated by each
producer minus the value of intermediate products.
 Only new production of goods and services counts
toward GDP.
CHAPTER 2 Measuring the Macroeconomy
What Is Included in GDP and What’s Not?
 Only goods and services that are transacted through markets are
included in GDP.
 GDP does include expenditures we’d rather not make:
 Controlling crime
 Defending against enemies
 Disposing of waste
 GDP does not include a measure of the health of a nation’s people.
 GDP does not include changes in environmental resources.
 GDP does not include household production.
 GDP does not include the value of leisure.
 GDP does not include illegal or underground activities.
CHAPTER 2 Measuring the Macroeconomy
•Nominal GDP is measured in current dollars while Real GDP is measured in
constant year dollars, e.g., Year 2009 dollars or Year 2010 dollars.

If the quantity of goods and services produced does not change, but prices do change, then nominal
GDP will change though nothing really changes.

In an economy with multiple goods, we must use one year’s prices to compute real GDP across time.

The magnitude of the change in real GDP will depend on the year’s prices we select to calculate real
GDP.

Chain weighting is preferred because new goods are invented while others become obsolete – rending
prices
relatively
high or
on such goods in the initial or final years.
CHAPTER
2 Measuring
thelow
Macroeconomy
Using Chain-Weighted Data
 The sum of real chain-weighted consumption,
investment, government purchases and net exports
will not equal real chain-weighted GDP because the
prices used in constructing the different components
are different.
 When interested in the shares of particular
components of GDP, look at the ratio of nominal
variables.
 When interested in real rates of economic growth,
use the chain-weighted real measures.
CHAPTER 2 Measuring the Macroeconomy
Price Indexes and Inflation
 The GDP deflator is the price level that satisfies the equation:
nominal GDP = price level * real GDP.
 The percentage change in nominal GDP is approximately equal to
the percentage change in the price level plus the percentage change
in real GDP.
 The inflation rate is the percentage change in the price level.
CHAPTER 2 Measuring the Macroeconomy
Comparing Economic Performance across Countries
 The exchange rate is the price at which different currencies are traded.
 To make comparisons of GDP across countries we must take the following two steps:
 GDP must first be adjusted by the exchange rate – so that GDP is expressed in a
common currency, usually the U.S. dollar.
 Second, once in a common currency, this value of nominal GDP must be
multiplied by the ratio of prices in the countries.
 The result is each country’s GDP in Purchasing Power Parity dollars.
 In general, rich countries tend to have higher price levels than poor countries.
 This is mainly because poor countries are less productive in their export and import
competing industries and therefore have lower wages in all industries.
CHAPTER 2 Measuring the Macroeconomy