Gross Domestic Product Measures Total Production
Gross domestic product (GDP) The market
value of all final goods and services produced
in a country during a period of time, typically
one year.
GDP Is Measured Using Market Values, Not Quantities
The worth of a thing is the price it will bring.
Final good or service A good or
service purchased by a final user:
•Household consumption
•Business investment, including all
residential construction
•Government purchases
•Exports to foreigners
vs
Intermediate good or service
A good or service that is an
input into another good or
service, such as a tire on a
truck.
GDP Includes Only Current Production
PRODUCTION AND PRICE STATISTICS FOR 2011
(1)
PRODUCT
(2)
QUANTITY
(3)
PRICE PER UNIT
100
$50.00
Pizzas
80
10.00
Textbooks
20
100.00
2,000
0.10
Eye examinations
Paper (for textbooks)
PRODUCT
(1)
QUANTITY
(2)
PRICE PER UNIT
(3)
VALUE
Eye examinations
100
$50
$5,000
Pizzas
80
10
800
Textbooks
20
100
2,000
Total GDP = $7,800
Production, Income, and the Circular Flow Diagram
Im
G + Tr
C
T
NX = X - Im
Deficit
G
T
X
I = Sprivate
- NX - Deficit
Sprivate
Y: Components of GDP = $16.0 trillion (2013:Q1)
C: Personal Consumption Expenditures = “Consumption” = 71.0% of Y
Consumption Spending by households on goods and services,
not including spending on new houses.
I: Gross Private Domestic Investment, or “Investment” = 13.4% of Y
Investment Spending by firms on new factories, office buildings,
machinery, and additions to inventories, and spending by
households on new houses.
G: Government Consumption and Gross Investment,or
“Government Purchases” = 19.0 % of Y
Government purchases
Spending by federal, state, and local governments on goods and services.
NX: Net Exports of Goods and Services, or “Net Exports” = -3.4% of Y
X = 13.7 % of Y
Im = 17.1% of Y
Transfer payments are not included in GDP:
Payments by the government to individuals for which the
government does not receive a new good or service in return.
•Unemployment benefits paid to someone not working.
•Social security benefits paid to someone who is retired.
•Interest income paid to a government bondholder
Since the government doesn’t produce anything for
the market, the interest payment can’t be for any
productive service.
“Underground economy” activities are not included in GDP
•Production “off-the-books”
•Illegal activities
Household production is not included in GDP
Does GDP Measure What We Want It to Measure?
Shortcomings of GDP as a Measure of Well-Being
The Value of Leisure Is Not Included in GDP
GDP Is Not Adjusted for Pollution or
Other Negative Effects of Production
GDP Is Not Adjusted for Changes in
Crime and Other Social Problems
GDP Measures the Size of the Pie but
Not How the Pie Is Divided Up
Per Capita Real GDP and Life Satisfaction
• Consumer spending on
services is greater than the sum of
spending on durable and nondurable goods.
• Business fixed investment is the largest component of
investment. Gross private domestic investment includes
New plant and equipment
New residential construction
Net additions to business inventories
• Purchases made by state and local governments are greater
than purchases made by the federal government.
• Imports are greater than exports
 net exports are negative.
Consumption expenditures
$800
Investment expenditures
200
Government purchases
300
Exports
100
Imports
200
Wages
800
Consider the data above (in billions of dollars) for an economy:
Gross domestic product (in billions of dollars) for this economy
equals
A) $2,200.
B) $1,600.
C) $1,400.
D) $1,200.
Measuring GDP by the Value-Added Method
Value added The market value a
firm adds to a product.
FIRM
VALUE OF PRODUCT
VALUE ADDED
Value of raw cotton = $1
Value added by cotton
farmer
=1
Value of raw cotton woven
into cotton fabric = $3
Value added by cotton
textile
mill = ($3 – $1)
=2
Shirt
Company
Value of cotton fabric made
into a shirt = $15
Value added by shirt
manufacturer = ($15 –$3)
= 12
L.L. Bean
Value of shirt for sale on
L.L. Bean’s Web site = $35
Value added by L.L. Bean
= ($35 – $15)
= 20
Cotton
Farmer
Textile Mill
Total Value Added
= $35
Real GDP versus Nominal GDP
Nominal GDP The value of this
year’s final goods and services
evaluated at this year’s prices.
Real GDP The value of this year’s
vs final goods and services evaluated
at base-year prices.
2000
PRODUCT
2009
QUANTITY
PRICE
QUANTITY
PRICE
Eye examinations
80
$40
100
$50
Pizzas
90
11
80
10
Textbooks
15
90
20
100
PRODUCT
2009
QUANTITY
2000
PRICE
Eye examinations
100
$40
$4,000
Pizzas
80
11
880
Textbooks
20
90
1,800
VALUE
Comparing Real GDP and Nominal GDP
Nominal GDP and
Real GDP, 1990–2006
The GDP Deflator
GDP deflator A measure of the price
level, calculated by dividing nominal GDP
by real GDP and multiplying by 100.
$ GDP = Price Level x Real Output
$Y = P x Y
P = $Y/Y
GDP deflator 
Nominal GDP
 100
Real GDP
If the GDP deflator is greater than 100, real GDP is
greater than nominal GDP.
a) True
b) False
c) The GDP deflator measures the general price
level and has nothing to do with GDP, nominal
or real, which measure output.
Increase in real GDP would overstate the increase of
well-being in a country over time if
a)
b)
c)
d)
e)
average hours worked per week increased
the amount of pollution increased
the crime rate increased
All of the above
None of the above
Other Measures of Total Production and Total Income
Gross National Product (GNP)
=GDP + Net Foreign Earnings of US Residents
•Compensation of employees earned abroad
•Interest and profits earned abroad
Net National Product (NNP) = GNP - Capital Consumption
Allowance (depreciation)
National Income (NI) = NNP - Indirect Business Taxes
= Income earned from production of national product
Personal Income (PI) = NI + Net Transfer Payments
Disposable Income (DI) = PI - Income Taxes
•Disposable Income is split between consumption and saving
Other Measures of Total Production and Total Income
FIGURE 7-4
Measures of Total Production
and Total Income, 2006
Other Measures of Total Production and Total Income
The Division of Income
FIGURE 7-5
The Division of Income
Key Terms
Business cycle
Macroeconomics
Consumption
Microeconomics
Economic growth
Net exports
Expansion
Nominal GDP
Final good or service
Price level
GDP deflator
Real GDP
Government purchases
Recession
Gross domestic product (GDP)
Transfer payments
Inflation rate
Underground economy
Intermediate good or service
Value added
Investment