1. Measuring a Nation’s Income
The Economy’s Income & Expenditure
The Measurement of Gross Domestic Product (GDP)
The Components of GDP
Real versus Nominal GDP
GDP and Economic Well-Being

2. The Economy’s Income & Expenditure
GDP measures two things simultaneously: total income in the economy and total expenditure in the economy
Recall that circular flow illustrates value of output = expenditures = income

3. The Economy’s Income & Expenditure
Leakage: Income earned, but not spent on goods and services
Injection: Expenditures on goods and services that do not come from household sector

4. The Economy’s Income & Expenditure
In spite of leakages and injections, every transaction has a buyer and seller, so income and expenditure will always be equal
This means we can measure GDP by adding up all expenditures in the economy or by adding up all incomes in the economy

5. The Measurement of Gross Domestic Product
GDP is the market value of all final goods and services produced within a country in a given time period

6. The Measurement of Gross Domestic Product
“Market value” implies we will be using prices as the value of goods and services
GDP tries to includes all final goods and services produced
Ignores household production
Ignores underground economy
Intermediate goods are excluded

7. The Measurement of Gross Domestic Product
GDP includes final goods
Intermediate goods are excluded in order to avoid double counting

8. The Measurement of Gross Domestic Product
Money Value
Farmer grows wheat & sells to miller
Miller mills wheat & sells to baker
Baker converts to bread & sells to store
Store sells bread to consumer
TOTALS

9. The Measurement of Gross Domestic Product
GDP includes goods produced in the current time period
Used goods are excluded
GDP measures the value of output produced within a nation
This is different from GNP which measures the value of output produced by a nation’s current residents

10. The Components of GDP GDP can be divided into various components
Consumption
Investment
Government purchases
Net exports

11. The Components of GDP
Consumption is spending by households on goods and services with the exception of new housing
Largest component
Investment is spending on capital equipment, inventories, and structures, including household purchases of new housing
Least stable component

12. The Components of GDP
Government purchases is spending on goods and services by state, local, and federal government
Excludes transfer payments
Net exports is spending on domestically produced goods by foreigners (exports) minus spending on foreign goods by domestic residents (imports)

13. The Components of GDP GDP can be expressed as: Y = C + I + G + NX
This equation is an identity - true by definition

14. Real versus Nominal GDP
A change in GDP does not mean that there has been a change in the level of output
GDP is P x Q
GDP can change because of a change in price, a change in quantity, or a change in both

15. Real versus Nominal GDP
Distinguish between nominal and real GDP
Nominal GDP is output valued in current dollars or current prices
Can change because of a change in output or a change in prices

16. Real versus Nominal GDP
Real GDP is output valued in constant dollars or constant prices (prices of some base period)
Can change only because of a change in output (we are essentially holding prices constant)

17. Real versus Nominal GDP
Year P of Pizza Q of Pizza P of Coke Q of Coke
$ $
$ $
Nom GDP1999 = (1.00 X 100) + (.5 X 50) =
Nom GDP2000 = (1.50 X 175) + (.6 X 75) =
Real GDP1999 = (1.00 X 100) + (.5 x 50) =
Real GDP2000 = (1.00 X 175) + (.5 X 75) =

18. Real versus Nominal GDP
The GDP deflator is a measure of the price level
It measures the current level of prices relative to the base year level of prices
The GDP deflator is calculated as the ratio of nominal GDP to real GDP multiplied by 100
The deflator for the base year will always be 100

19. Real versus Nominal GDP
The deflator can be use to examine price changes that have occurred since the base year
A GDP deflator of means prices are 6.7% higher than in base period

20. Real versus Nominal GDP
The GDP deflator can be used to calculate changes in prices over some period of time other than the base
Current deflator - Old deflator X 100
Old deflator

21. Real versus Nominal GDP
Example
Price index 1995 = 120
Price index 1999 = 135
Change in price is:
X 100
120

22. Real versus Nominal GDP
15 X 100
120
= .125 X 100
= 12.5 percent change in prices

23. GDP and Economic Well-Being
GDP is an indicator of economic well-being
Should be aware that it is a flawed indicator
Does not include leisure, quality of the environment, types of goods we produce, value of goods that are produced outside markets, etc.

24. GDP and Economic Well-Being
(Gross domestic product) does not allow for the health of our children, the quality of their education, or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our courage, nor our wisdom, nor our devotion to our country. It measures everything, in short, except that which makes life worthwhile, and it can tell us everything about America except why we are proud to be Americans Robert Kennedy