PART FIVE
Macroeconomic
Measurement, Models,
and Fiscal Policy
Chapter 12:
Introduction to GDP,
Growth, and Instability
Gross Domestic Product
Gross domestic product (GDP) is the
total market value of all final goods and
services produced annually within the
U.S., whether by U.S. or foreign-supplied
resources.

GDP is determined by the Bureau of
Economic Analysis (BEA), an agency of the
Commerce Department, and is the primary
measure of the economy’s performance.
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Gross Domestic Product

GDP is a monetary measure.


It compares the relative value of goods and
services produced in different year.
To avoid counting components that are
bought and sold multiple times, GDP
includes on the market value of final goods
and ignores intermediate goods
altogether.
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Gross Domestic Product

Secondhand goods are also excluded
from GDP since they do not contribute to
current production.

These goods were previously counted in the
year they were produced.
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Measuring GDP

The four categories of expenditures that
provide a measure of the market value of
total output in a particular year include:




Personal consumption expenditure (C)
Gross Private Domestic Investment (Ig)
Government Purchases (G)
Net Exports (Xn)
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Personal consumption
expenditure (C)

All expenditures by households on durable
consumer goods, nondurable consumer
goods and consumer expenditure for
services are included in personal
consumption expenditure.
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Gross Private Domestic
Investment (Ig)

Gross private domestic investment
includes (1) all final purchases of
machinery, equipment, and tools by
business enterprises, (2) all construction,
and (3) changes in inventories.
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Measuring GDP


Government purchases includes
spending for products that government
consumes in providing public services and
expenditure for social capital.
Net exports are exports minus imports.
Adding It Up: GDP = C + Ig + G + NX
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Nominal GDP versus Real GDP


It is difficult to compare values over time
without correcting them for inflation or
deflation.
The monetary value of GDP changes from
year to year either due to changes in
prices and output.

Nominal GDP, or unadjusted GDP, is gross
domestic product in terms of the price level at
the time of measurement.
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Nominal GDP versus Real GDP

To compare the market value of the
quantity of goods and services produced
from year to year, an adjustment to inflate
GDP when prices rise or deflate GDP
when prices fall is required.
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Nominal GDP versus Real GDP

Real GDP, or adjusted GDP, is gross
domestic product measured in terms of the
price level in a base period (or reference
year).

It is a GDP that has been deflated or inflated
to reflect changes in the price level.
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Economic Growth
An expansion of real GDP (or real GDP
per capita) over time is economic growth.


It is calculated as a percentage rate of growth
per quarter or per year.
Real GDP per capita (or output per person) is
found by dividing real GDP by the size of the
population.
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Economic Growth


Economic growth is an economic goal of
government since it raises the standards
of living in society and lessens the burden
of scarcity.
Two fundamental ways society can
increase its real output and income are:


by increasing its inputs of resources
by increasing the productivity of those inputs
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Business Cycles

Business cycles are recurring increases
and decreases in the level of economic
activity over periods of time.


The four phases of a business cycle are
recession, trough, expansion and peak.
Individual cycles vary substantially in duration
and intensity.
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Business Cycles
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Business Cycles

The two primary phases are recession and
expansion.

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A recession is a period of declining real GDP,
accompanied by lower income and higher
unemployment.
An expansion is a generalized increase in
output, income, and business activity.
The twin problems that arise from business
cycles are unemployment and inflation.
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Unemployment

The Bureau of Labor Statistics (BLS) is
charged with reporting unemployment
figures, such as the number of persons
employed, the unemployment rate, and
the number of persons in the labor force.

Data is based on a monthly nationwide
random survey of some 60,000 households.
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Measurement of
Unemployment

The total U.S. population is divided into
three groups.
1) People under 16 years of age and those who
are institutionalized
2) Adults that are “not in the labor force”; those
who are potential workers but are not
employed and not seeking work
3) Adults who are in the labor force; those who
are either employed or unemployed and
seeking work
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Measurement of
Unemployment
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Measurement of
Unemployment
The unemployment rate is the
percentage of the labor force unemployed.
unemployed
Unemployment rate =
x 100
labor force
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Types of Unemployment

The three types of unemployment are
frictional, cyclical, and structural.


Frictional Unemployment, consisting of
search unemployment and wait
unemployment, is unemployment that is
associated with people searching for jobs or
waiting to take jobs in the near future.
Cyclical Unemployment is unemployment
that is associated with the recessionary phase
of a business cycle.
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Types of Unemployment

Structural Unemployment is unemployment
that is associated with a mismatch between
available jobs and the skills or locations of
those unemployed.

Changes over time in consumer demand and in
technology alter the “structure” of the total
demand for labor, causing this type of
unemployment.
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Definition of Full Employment


Full employment occurs when the
economy experience only frictional and
structural unemployment; there is no
cyclical unemployment.
The level of real GDP that would occur if
there was full employment is called
potential output.
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Economic Cost
of Unemployment


Forgone output is the basic economic cost
of unemployment.
If actual GDP is above or below potential
GDP, the result is a GDP gap.
GDP gap = actual GDP – potential GDP
 When actual GDP is less than potential GDP,
there is a negative GDP gap accompanied
with a higher unemployment rate and
foregone income.
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Inflation

Inflation is a rise in the general level of
prices in an economy.

When there is inflation, each dollar of income
buys fewer goods and services; the
purchasing power of money declines.
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Inflation

On average, the prices of goods and
services are rising; however, not all prices
go up—the prices of some products
remain fairly constant or decrease.
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Measurement of Inflation
The main measure of inflation in the U.S.
is the Consumer Price Index, or CPI.


The CPI is an index that compares the price of
a market basket of goods and services in one
period with the price of the same (or highly
similar) market basket in a base period,
currently 1982-1984.
The CPI includes some 300 products that are
presumably purchased by the typical
consumer.
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Measurement of Inflation

CPI for any particular year equals:
price of the most recent market basket in the particular year
price of the same market basket in 1982-1984


The composition of the market basket is
updated every two years.
The rate of inflation for a certain year is
found by comparing, in percentage terms,
that year’s index with the index in the
previous year.
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Types of Inflation

Demand-pull inflation is increases in the
price level caused by excessive spending
beyond the economy’s capacity to produce.


Excess demand from expanding output bids up
the prices of the limited output.
Cost-push inflation is increases in the price
level caused by sharp rises in the cost of key
resources.

Supply shocks are the main source of cost-push
inflation.
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Redistribution Effects
of Inflation



Inflation redistributes real income from
some people to others.
Nominal income is the number of dollars
received as wages, rent, interest, and
profits.
Real income is a measure of the amount
of goods and services nominal income can
buy; it is the purchasing power of nominal
income.
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Redistribution Effects
of Inflation
Nominal income
Real income =
Price index (in hundredths)


When inflation occurs, some nominal
incomes do not rise in proportion to the
price level.
Thus, real income is affected.
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Who is Hurt by Inflation?


Fixed-income receivers, savers and
creditors are hurt by unanticipated
inflation.
Inflation redistributed income away from
them and toward others.

Fixed-income receivers’ real incomes fall, the
real value of accumulated savings
deteriorates, and the value of the dollar goes
down when there is unanticipated inflation.
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Who is Unaffected or
Helped by Inflation?

Flexible-income receivers are either
unaffected or helped by inflation.


Some incomes are indexed for inflation while
other incomes rises faster than the price
index, resulting in higher real incomes.
As inflation reduces the value of the dollar,
debtors (or borrowers) are helped.
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Anticipated Inflation


If people can anticipate inflation and can
adjust their nominal incomes to reflect the
expected price-level rises, then the
redistribution effects of inflation are less
severe or are eliminated altogether.
Furthermore, the redistribution of income
from lender to borrower may be altered.

Lenders can build in their expectations of
inflation in setting interest rates on loans.
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Does Inflation Affect Output?


Inflation may affect a nation’s level of real
output and real income.
The direction and significance of this effect
on output depends on the type of inflation
and its severity.


Cost-push inflation reduces real output.
Demand-pull inflation causing mild inflation may
reduce real output, according to some
economists, but can increase real output and
lead to economic growth according to others.
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Hyperinflation

Another type of inflation is hyperinflation,
an extraordinarily rapid inflation that
disrupts normal economic relationships.

As average prices rise steeply and
unpredictably, money eventually becomes
worthless since its purchasing power erodes
and a state of barter may arise.
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