 # Unit 1 – Macroeconomic Measurement and Basics Concepts Chapter 7 – Measuring Domestic Output and National Income.

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Unit 1 – Macroeconomic Measurement and Basics Concepts Chapter 7 – 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): George has a sheep farm. He produces a bushel of wool. Eunice has a textile mill, she buys the wool from George for \$100 and produces cloth. Ellen is a tailor. She buys the cloth from Eunice for \$200 and makes a suit that she sells to Dao 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: - George produced \$100 worth of wool. - Eunice added \$100 of value to that wool to make \$200 worth of cloth. - Ellen 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 (I g ) 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 (X n ) (Exports – Imports) (example of the Toyota factory in Kentucky) GDP = C + I g + G + X n

Nominal GDP vs. Real GDP Year 2000 – We produce 1 car with a final price tag of \$25,000. So GDP for 2000= \$25,000 Year 2013 - We produce the same kind of car with a final price tag of \$30,000 So GDP for 2013 = \$30,000 OK, we know that doesn’t really reflect reality. Output did not actually grow. We call these figures nominal GDP.

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 yearx 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 2013x 100 Value of market basket in 2000 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=\$225,000 = \$169,172 (Price Index ÷ 100) (133/100) 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.

YearNominal GDP (In Billions of \$) Price Index (GDP Deflator) Real GDP (In Billions of \$) 19802795.657.05 19854213.073.69 19905803.26707.9 19957400.57543.8 19967813.2 200210,446.2110.66 1.Complete this table. 2.Which one of these is probably the base year? How do you know?

YearNominal GDP (In Billions of \$) Price Index (GDP Deflator) Real GDP (In Billions of \$) 19802795.657.054900.3 19854213.073.695717.2 19905803.286.516707.9 19957400.598.107543.8 19967813.21007813.2 200210,446.2110.669439.9 1.Complete this table. 2.Given that the base year is one of these years, which one is it? How do you know?

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