Chapter 7

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Chapter 7: Measuring Domestic Output and National Income
Assessing the Economy’s Performance
 Compares levels of production (every 3 months)
 Track fluctuations in growth
 Used to create policies to address issues
Gross Domestic Product
 Annual total value of output of goods and services
(aggregate output)
A Monetary Measure
 Compares relative values of
goods and services in
different years
 GDP = C + I + G + (X-M)
Counting Goods
 Intermediate Goods
 In need of further processing
 Final Goods
 Ready for consumption
Avoid Multiple Counting
 GDP ignores intermediate goods
Value Added
 Value of firm’s output less value of inputs the firms have
bought
GDP Exclusions
 Financial Transactions

Soc. Sec., Welfare
 Private Transfer Payments

Funds transferred from one person to another
 Stock Market Transactions

Buying and selling stocks (just paper; no production)
 Second Hand Sales

“Ebay”
Aggregate Spending
 Spending on output comes from 4 sectors
 Consumer Spending (C)
 Investment Spending (I)
 Government Spending (G)
 Net Exports (X-M)
GDP = C + I + G + (X-M)
Consumer Spending (C)
 Personal Consumption
Expenditures
 Covers all consumer
goods and services
 Largest source of
spending
GDP = C + I + G + (X-M)
Investment Spending (I)
 Expenditures to
increase output later
 New capital
machinery purchased
 New construction for
firms or consumers
 Market value of the
change in unsold
inventories
GDP = C + I + G + (X-M)
Government Spending (G)
 Expenditures on goods, services, infrastructure, etc.
 Does not include spending on benefits
GDP = C + I + G + (X-M)
Net Exports (X-M)
 Foreign bought US goods (X)
 Subtract total imports (M)
GDP = C + I + G + (X-M)
GDP Practice
The following list shows the total expenditures in the private,
public and foreign sectors in the United States in 2009 (in
billions of dollars).
 Household Consumption (C) = 10,001
 Private Investment (I) = 1,590
 Government Expenditures (G) = 2,914
 Net Exports (X-M) = -386.
 Calculate total US GDP for 2010.
Total GDP = 10,001 + 1,590 + 2,914 +(-386) = $14,119 billion
GDP = C + I + G + (X-M)
The Income Approach to GDP
 The sum of all income sources is approximately equal
to the sum of all spending sources (GDP)
RESOURCE SUPPLIED
INCOME RECEIVED
Labor
Wages
Land
Rent
Capital
Interest
Entrepreneurial Talent
Profits
GDP = C + I + G + (X-M) = Aggregate Spending
Comparing GDP over time by accounting for different
prices over time
Nominal GDP (“Current Dollar”, “Money” GDP)
 Value of current production at current prices
Real GDP (“Constant Dollar” GDP)
 Value of current production, but using prices from a point
of time to evaluate inflations impact
 Example: Valuing 2003 production at 2002 prices creates 2003
Real GDP
Nominal to Real GDP Example
 Suppose GDP is made up of just one product, cups of latte. The table shows how many
lattes have been made in a four-year period, the prices, and a price index. We need a
price index in order to calculate real GDP. This index is a measure of the price of a good
in a given year, when compared to the price of that good in a reference (or base) year.
Using 2000 as the base year, the index is used to adjust nominal GDP to real GDP for this
one good. First the latte price index, or LPI.
LPI in year t = 100 x (Price of a latte in year t) / (Price of a latte in base year)
YEAR
# OF
LATTES
PRICE PER
CUP
NOMINAL
GDP
PRICE
INDEX
REAL GDP
2000
1,000
$2
$2,000
= 100 x $2/$2
= 100
= $2,000
2001
1,200
$3
$3,600
150
$2,400
2002
1,800
$4
$7,200
200
$3,600
2003
1,600
$5
$8,000
250
$3,200
The GDP Price Deflator
 Used to calculate the rate of price inflation for all goods
produced in a nation
 Used for signs of growth and recession
GDP Deflator =
Nominal GDP
Real GDP
X 100
GDP Price Deflator Practice
If nominal GDP is $100 billion and real GDP is
$80 billion, what is the deflator?
2. If Real GDP is $200 billion and deflator is 120
what is the nominal GDP?
3. If nominal GDP is $300 billion and the deflator is
150 what is the real GDP?
1.
GDP Deflator =
1. Deflator is 125
Nominal GDP
Real GDP
X 100
2. Nominal GDP is $240
billion
3. Real GDP is
$200 billion
Is inflation bad?
Consumer Price Index (CPI)
 Measures average price level of consumers goods actually bought
 EXAMPLE using “Market basket of goods”
2000 (Base Period)
Items in the
“Market Basket”
2001 (Current Period)
Spending
Price
Spending
Quantity
Purchased
Price
Chocolate Bars
12
$1.50
$18
$1.75
$21
Concert Tickets
4
$45
$180
$60
$240
Compact Discs
18
$16
$288
$15
$270
Total Spending
on 2000
Quantities
=$486
=$531
CPI
Price Index current year = 100 x (Spending current year) / (Spending base year)
2000 (Base Period)
Items in the
basket
2001 (Current Period)
Quantity
Purchased
Price
Spending
Price
Spending
on 2000
Quantities
Chocolate Bars
12
$1.50
$18
$1.75
$21
Concert Tickets
4
$45
$180
$60
$240
Compact Discs
18
$16
$288
$15
$270
Total Spending
=$486
=$531
 So, 2001 price index = 100 x (531) / (486) = 109.26
 Annual rate of inflation is the
percentage change in CPI from
one year to another
 Consumers can see a “cost of
living adjustment” to income to
keep up with inflation
Inflation
Nominal and Real Income
 Nominal = Income in actual
currency terms unadjusted for
inflation
 Real = Inflation-adjusted
income
Real income = (nominal income this year) / CPI (in hundredths)
Real Income Example
 Real income = (nominal income this year) / CPI (in hundredths)
 Real income 2002 = $40,000 / 1.816 = $22,026
 Real income 2003 = $41,000 / 1.850 = $22,162

Real income increased by $136
What if the wages did not increase from 2002 to 2003? What would happen
to this persons purchasing power?
Real income 2003 = $40,000 / 1.85 = $21,622 (decrease of $404)
Real Income Activity
Expected Inflation
 Banks factor expected inflation through nominal interest rates
 Nominal Interest Rate = Real interest rate + Expected inflation
Unexpected Inflation and Examples
 Effects of unpredictable inflation
 Employers and employees

Due to rapid inflation workers nominal
income rise by 8%, but prices of goods
rise by 10%, the employer has the
advantage
 Fixed income earners
 If inflation rises but minimum/transfer
payments do not their purchasing power
greatly diminishes
 Savers and borrowers
 Savers put money into accounts but
inflation rises higher than expected hurts
the saver
 Borrowers take out a loan then inflation
rises unexpectedly it hurts the lenders
Unemployment
 Frictional
 Fired employees, newly
entered workers
 Seasonal
 Periodic and predicted
job loss
 Structural
 Changes to a field that
causes loss of job
 Cyclical
 Job loss pending the
health of the economy
Full Employment
 No cyclical unemployment = full employment
 Natural Rate of Unemployment in US is 4-6%

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