1. Chapter 4: Measuring GDP and Economic Growth
Definition of GDP
Use circular flow model to explain how GDP can be measured from income or expenditure side.
Measurement of GDP and its major components.
GDP as a measure of economic growth.
Limitations 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.
Exclude sale/purchase of 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 since it reflects goods produced but not sold during 2010.
If inventories fall by $10 million during 2010, $10 million is subtracted from sales of final goods & services because $10 million was sold during 2010 that was produced prior to 2010.

4. GDP and Circular Flow
Households sell factors of production the 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 of goods 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 (blue flows) or expenditure (red) 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. If capital is $8 trillion at the end of 2008 and $7
If capital is $8 trillion at the end of 2008 and $7.7 trillion at the end of 2009
Gross investment is $.3 trillion in 2009
Gross investment is -$.3 trillion in 2009
Net investment is $.3 in 2009
Net investment is -$.3 trillion in 2009 10

10. GDP: The Expenditure Side

11. 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

12. GDP: The Income Side

13. 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.

14. 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)

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

18. Real GDP and the Price Level
2002 NGDP ________
2003 NGDP ________
Base year of 2002
2002 RDGP ________
2003 RGDP ________
Item
Quant.
Price
2002
Balls
100
$1.00
Bats 20
$5.00
2003
160 22
$10.00

19. For your answers to the next several slides, give your estimates of GDP to the nearest dollar, do not include decimals, and do not include $ signs.

21. 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.

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

23. 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.

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

25. Real GDP per capita across the world
Source:

26. 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