Unit 1 – Macroeconomic
Measurement and Basics
Concepts
Chapter 25 – Measuring
Domestic Output and National
Income
Essential Questions
1. How do we measure the nation’s economic
output?
2. How do we compare the nation’s economic
output from year to year in the face of
changing prices?
National Income Accounting measures the economy’s
overall performance.
The most commonly used measure is Gross Domestic
Product (GDP).
GDP is the total market value of all final goods and
services in a given year produced by resources employed
within this country.
- Must avoid multiple counting:
- Count only final goods or
- Count only value added at each step.
Avoiding multiple counting (example):
Marc has a sheep farm. He produces a bushel of wool.
Amelia has a textile mill, she buys the wool from Marc for
$100 and produces cloth.
Evelyn is a tailor. She buys the cloth from Amelia for $200
and makes a suit that she sells to Gaige for $300.
How much do we count toward GDP?
1. Either count just the final good – the $300 suit.
2. Or count the value that each person added:
- Marc produced $100 worth of wool.
- Amelia added $100 of value to that wool to make $200
worth of cloth.
- Evelyn added $100 of value to that cloth to make a
$300 suit.
$100 + $100 + $100 = $300
GDP excludes “non-production” transactions:
1. Financial transactions
a. Public transfer payments
b. Private transfer payments
c. Stock market transactions (brokers fees are included).
2. Second-hand sales. (anything “used”)
There are two methods of computing GDP: Spending and
Income. We’re going to look at the spending, or Expenditures
Approach.
But, and this is very important, the income approach gives you
the same result. GDP
= NATIONAL INCOME.
The Expenditures Approach - Add together all of these:
1. Personal Consumption Expenditures (C)
2. Gross Private Domestic Investment (Ig)
a. Final purchases of machinery, equipment and tools by
businesses.
b. All construction.
c. Changes in inventories (can be positive or negative).
3. Government Purchases (G)
4. Net Exports (Xn)
(Exports – Imports) (example of the Toyota factory in Kentucky)
GDP = C + Ig + G + Xn
Nominal GDP vs. Real GDP
Year 2000 – We produced 1 car with a final price tag of $25,000.
So GDP for 2000= $25,000
Year 2013 - We produced the same kind of car with a final price
tag of $30,000
So GDP for 2013 = $30,000
But we know that doesn’t really reflect reality. Output did not
actually grow. We call these figures nominal GDP.
Nominal GDP increased but Real GDP did not.
Nominal GDP vs. Real GDP
Year 2000 – We produce 10 cars ($15,000 each) and 40
computers ($500 each).
(10 x 15,000) + (40 x 500) = $170,000
So GDP for 2000 = $170,000
Year 2013 - We produce 10 cars ($20,000 each) and 40
computers ($625 each)
(10 x 20,000) + (40 x 625) = $225,000
So GDP for 2013 = $225,000
Again, output did not actually grow. Only nominal GDP
increased.
Nominal GDP vs. Real GDP
Year 2000: Nominal GDP = $170,000
Year 2013: Nominal GDP = $225,000
Real GDP is how we adjust these numbers to show actual
growth.
First, choose a base year. We’ll use 2000. Then we calculate a
price index for that year.
Price Index = Value of market basket in a given year x 100
Value of market basket in base year
So the Price Index for the base year is always 100.
Nominal GDP vs. Real GDP
Year 2000: Nominal GDP = $170,000
Year 2013: Nominal GDP = $225,000
Price Index for 2000 is 100.
Price Index for 2013 =
Value of market basket in 2013
Value of market basket in 2000
x 100
Let’s say our market basket is 1 car and 1 computer.
Price Index for 2013 = 20,625 x 100 = 133
15,500
Nominal GDP vs. Real GDP
Year 2000: Nominal GDP = $170,000
Year 2013: Nominal GDP = $225,000
Price Index for 2013 = 20,625 x 100 = 133
15,500
Now we can calculate Real GDP for 2013:
__Nominal GDP__ = $225,000
(Price Index ÷ 100)
(133/100)
= $225,000 = $169,172
1.33
OK, this is close, but shouldn’t they be exact if we produced
the exact same amount of goods? Anybody have any
explanations for this?
Nominal GDP vs. Real GDP
To summarize:
To find Real GDP:
Divide Nominal GDP by (Price Index/100).
Price Index is also called the GDP Deflator because you use
it to deflate inflated Nominal GDP figures back to Real GDP
figures.
And one last thought: the Price Index (GDP Deflator) can
sometimes actually be an inflator if the price index is less than
100.
Year
Nominal GDP
Price Index
Real GDP
(In Billions of $) (GDP Deflator) (In Billions of $)
1980
2795.6
57.05
1985
4213.0
73.69
1990
5803.2
6707.9
1995
7400.5
7543.8
1996
7813.2
7813.2
2002
10,446.2
110.66
1. Complete this table.
2. Given that the base year is one of these years, which
one is it? How do you know?
Year
Nominal GDP
Price Index
Real GDP
(In Billions of $) (GDP Deflator) (In Billions of $)
1980
2795.6
57.05
4900.3
1985
4213.0
73.69
5717.2
1990
5803.2
86.51
6707.9
1995
7400.5
98.10
7543.8
1996
7813.2
100
7813.2
2002
10,446.2
110.66
9439.9
1. Complete this table.
2. Given that the base year is one of these years, which
one is it? How do you know?
Homework:
Read 557 (start with Nominal GDP v. Real GDP) - 564.
Do Discussion Questions 2, 4, 5, 7, & 10 on p. 565.
Do Problems 1, 2, 6, & 7 on p 566 - 567.
Last night’s homework:
Discussion Questions:
2. Why do national income accountants compare the
market value of the total outputs in various years rather
than actual physical volumes of production? What
problem is posed by any comparison over time of the
market values of various total outputs? How is this
problem resolved?
4. Why do economists include only final goods and
services when measuring GDP for a particular year? Why
don’t they include the value of the stocks and bonds
bought and sold? Why don’t they include the value of the
used furniture bought and sold?
Last night’s homework:
Discussion Questions:
5. Explain why an economy’s output, in essence, is also its
income.
7. Why are changes in inventories included as part of
investment spending? Suppose inventories declined by
$1 billion during 2014. How would this affect the size of
gross private domestic investment and gross domestic
product in 2014? Explain.
10. Define net exports. Explain how U.S. exports and
imports each affects domestic production. How are net
exports determined? Explain how net exports might be a
negative amount.
Last night’s homework:
Problems:
1.
Quantity
of
Goods
Year 1
Price
Year 1
Good
Quarts of
ice cream
Nominal
Value of
Goods
Year 1
Quantity
of
Goods
Year 2
Price
Year 2
Nominal
Value of
Goods
Year 2
$4.00
3
$12.00
$4.00
5
$20.00
Bottles of
shampoo
3.00
1
3.00
3.00
2
6.00
Jars of
peanut
butter
2.00
3
6.00
2.00
2
4.00
—
—
$21.00
—
—
$30.00
Last night’s homework:
Problems:
2. These two transactions would add $160,000 to
personal consumption expenditures and thus to GDP
during the year. The reason that we do not count the
$70,000 is that this first sale is an intermediate step
toward the final sale and value of the flower bulbs sold to
consumers. This final price includes the cost of the bulbs
purchased by the Internet retailer.
Last night’s homework:
Problems:
6. Suppose that in 1984 the total output in a single-good
economy was 7,000 buckets of chicken. Also suppose that in
1984 each bucket of chicken was priced at $10. Finally, assume
that in 2005 the price per bucket of chicken was $16 and that
22,000 buckets were produced.
a. What is the GDP price index for 1984, using 2005 as the
base year? 62.5
b. By what percentage did the price level, as measured by
this index, rise between 1984 and 2005? 60%
c. What were the amounts of real GDP in 1984 and 2005?
In 1984, real GDP = $112,000.
In 2005, real GDP = $352,000.
Last night’s homework:
Problems:
7.
Year Nominal Price Index Real
GDP
(2005 =
GDP
100)
1968
909.8
22.01
4,133.58 inflating
1978
2293.8
40.4
5,677.72 inflating
1988
5100.4
66.98
7,614.81 inflating
1998
8793.5
85.51
10,283.59 inflating
2008
14,441.4
108.48
13,312.50 deflating