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Chapter 4: Measuring GDP and Economic Growth

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1 Chapter 4: Measuring GDP and Economic Growth
Objectives: Define GDP Income and expenditure approach Measurement of GDP and its major components. GDP as a measure of economic growth. Shortcomings of GDP as a measure of economic growth or the standard of living.

2 Definition of GDP GDP (Gross Domestic Product) is the market value of all final goods and services produced in a country in a given time period. Market value goods & services are valued at their market prices. GDP rises if prices rise (more on this later) Final goods and services Bought by final user Intermediate goods are produced by one firm, bought by another, and used as a component of a final good or service. Exlude intermediate goods to avoid double counting.

3 Definition of GDP Produced within a country In a given time period
Any domestic production, regardless of who owns the resources In a given time period Production during a specific year (sales of used items excluded, except value of service in sale) Inventory adjustments account for goods produced in one year but sold in another if inventories rise by $10 million during 2010, $10 million is added to sales of final goods & services If inventories fall by $10 million during 2010, $10 million is subtracted from sales of final goods & services

4 GDP and Circular Flow Households sell factors of production to firms in factor markets Factors of production: land, labor, capital Wages for labor Interest for loans used to purchase capital Rent for the use of land Profit to owners of capital Total income paid to households=Y

5 Expenditure Components of GDP
Consumption (C) total payment for consumer goods and services Investment (I) purchase of new plant, equipment, and buildings additions to inventories Government spending (G): government purchases ofgoods and services from firms excludes “transfer payments” such as Social Security, Unemployment Insurance Net exports (X-M) (exports-imports) Imports subtracted because counted as part of C,I,G and are not part of domestic production.

6 Y=total income; C=consumption; I=investment; G=government purchases; X-M=exports-imports=net exports

7 GDP: Income & Expenditure Approach
GDP can be measured by income or expenditure side Circular flow demonstrates that Y = C + I + G + (X-M)

8 Gross vs Net Domestic Product
GDP is before subtracting depreciation (capital consumption allowance) NDP =GDP- CCA NDP is “net of” depreciation. Capital in t = Capital in (t-1) + Gross Investment –CCA = Capital in (t-1) + Net Investment where Net investment = Gross investment – CCA

9 GDP: The Expenditure Side

10 GDP: The Income Side Income includes
1. Compensation of employees 2. Rental income 3. Net interest 4. Corporate profits 5. Proprietors’ income Two adjustments to income required: 1.Indirect taxes minus subsidies are added to get from factor cost to market prices. 2. Depreciation (or capital consumption) is added to get from net domestic product to gross domestic product

11 GDP: The Income Side

12 GDP: Adjusting for changes in prices
Nominal GDP the value of goods and services produced during a given year valued at the prices that prevailed in that same year. Nominal GDP is a more precise name for GDP. Real GDP the value of final goods and services produced in a given year when valued at the prices of a reference base year.

13 2000 2010 Product Quantity Price computers 100 $500 120 $600 refrigerators 50 $1000 $1500 Nominal GDP Real GDP (2000 base year) Real GDP (2010 base year) GDP-deflator (2000 base year) GDP-deflator (2010 base year)

14 GDP Deflator GDP deflator
Provides a comparison of current and base year prices




18 Lucas Wedge dollar value of the accumulated gap between what real GDP per person would have been if the 1960s growth rate had persisted and what real GDP per person turned out to be.

19 Temporary fluctuations in GDP: The Business Cycle
4 stages to a business cycle Peak Recession Trough Expansion

20 Comparing Standard of Living Across Countries
Use per capita real GDP Must make two adjustments Convert into common currency Goods and services must be valued at same prices Using the exchange rate to convert can be problematic because prices of some products may differ after conversion Purchasing Power Parity exchange rate is the exchange rate that would make the prices of goods and services equal across countries. Using actual exchange rate instead of PPP exchange rate causes underestimate of standard of living in less developed countries.

21 With actual exchange rates, China RGDP per capita is 5% of that in U.S.
With PPP exchange rates, China RDDP per capita is 12.5% of that in U.S.

22 Real GDP per capita across the world

23 Limitations of GDP as measure of standard of living
Household production Underground economic activity Health and life expectancy Leisure time Environmental quality Political freedom and social justice

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