1. Ch. 5 : MEASURING GDP AND ECONOMIC GROWTH
Define GDP
Circular flow model
Relationship between aggregate expenditure and aggregate income.
Measurement of real GDP and the GDP deflator
Real GDP as a measure of economic growth and the limitations of our measure

2. Gross Domestic Product
GDP: gross domestic product
the market value of all final goods and services produced in a country by domestically located resources in a given time period.
This definition has four parts:
Market value
Final goods and services
sales of intermediate goods not counted
Produced within a country by domestically located resources
In a given time period
Inventory changes between periods for partially completed products

3. Gross Domestic Product
GDP and the Circular Flow of Expenditure and Income
GDP measures the value of production
equals total expenditure on final goods
equals total income from production.
The circular flow diagram illustrates the equality of income, expenditure, and the value of production.

4. Produced in 2008 were not sold in 2008
Suppose that inventories are $20 billion at the end of 2008 and $24 billion at the end of 2009, this means that $4 billion of goods :
Produced in 2008 were not sold in 2008
Produced in 2009 were not sold in 2009
Produced in 2008 were sold in 2009 20

5. Sold in 2008 were produced prior to 2008
Suppose that inventories are $20 billion at the end of 2008 and $15 billion at the end of 2009, this means that $5 billion of goods :
Sold in 2008 were produced prior to 2008
Sold in 2009 were produced prior to 2009
Produced in 2009 were unsold in 2009 20

6. Circular Flow Red=expenditures, Blue=income, Green=borrowing/lending/taxes

7. Circular Flow Notation
Y=Total income
C=consumption
I=investment
G=government purchases
X-M=exports-imports (net exports
T=net taxes=taxes-transfers
S=household saving

8. Circular Flow For any given sector, inflows=outflows Household sector:
Y=C+S+T
Factor markets
Y=C+I+G+(X-M)
Government
T-G=government lending (borrowing)

9. Circular Flow Rest of World Financial markets
X-M=U.S. lending (borrowing) with rest of world
Financial markets
S + government budget surplus (deficit) = lending (borrowing) with rest of world

10. Gross Domestic Product
Two ways to measure GDP:
Expenditure Approach:
Aggregate expenditure = C + I + G + (X-M)
Income Approach
Aggregate income = Y = Wages + Rent + Interest + Profit
Because Income and expenditure approach both measure GDP:
Y = C + I + G + (X-M)

11. Expenditure Components of US GDP: 2008 (billions of $)

12. Gross Domestic Product
Financial Flows
Y = C + S + T
Y = C + I + G + (X-M)
S+T = I+G+(X-M)

13. Gross Domestic Product
How Investment Is Financed
The last equation could also be reorganized as:
I = S + (T-G) + (M-X)
Investment is financed from three sources:
Private saving, S
Government budget surplus, (T – G)
S + (T-G) is “national saving”
Borrowing from the rest of the world (M – X).

14. Gross Domestic Product
Gross vs. Net Domestic Product
“Gross” means before accounting for the depreciation of capital.
Net Domestic Product = GDP – Capital Consumption Allowance.

15. Stocks versus flows Wealth Saving Capital Investment
a stock representing the value of all the things that people own
Saving
A flow that is the source of changes in the stock of wealth.
Capital
A stock representing the plant, equipment, and inventories of raw and semi-finished materials that are used to produce other goods
Investment
A flow representing the purchases of new capital
Depreciation (capital consumption)
A flow representing the decrease in the capital stock that results from wear and tear, and obsolescence.

16. Stocks vs flows
Wealth(t)=Wealth(t-1)+saving Capital(t)=Capital(t-1) + gross investment-depreciation =Capital(t-1) + net investment

17. If wealth is $26 trillion at the end of 2008 and $27
If wealth is $26 trillion at the end of 2008 and $27.3 trillion at the end of 2009, then saving was
$1.3 trillion during 2008
$1.3 trillion during 2009
-$1.3 trillion during 2008
-$1.3 trillion during 2009. 20

18. 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
Net investment is $.3 in 2009
Net investment is -$.3 trillion in 2009 20

19. Gross Domestic Product
The relationships among capital, gross investment, depreciation, and net investment.

20. Investment and Depreciation
Depreciation is included in:
GDP
Gross profits
Gross Investment
Depreciation is removed from
Net National Product
Net profits
Net investment
Investment plays a central role in the economy.
Increases in capital are one source of growth in potential real GDP
Fluctuations in investment are one source of fluctuations in real GDP.

21. Measuring U.S. GDP
The National Income and Product Accounts divide net national income into five categories
Compensation of employees
Net interest (paid by business)
Rental income
Corporate profits.
Proprietors’ income.

22. Measuring U.S. GDP
Two items must be added to net domestic income to get GDP
Indirect taxes minus subsidies are added to get from factor cost to market prices.
Depreciation (or capital consumption) is added to get from net domestic product to gross domestic product.

23. Real GDP and the Price Level
Nominal GDP is the value of final goods and services produced in a given year when valued at the same year’s prices
Real GDP is the value of final goods and services produced in a given year when valued at constant (base year) prices.

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

25. 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.

26. Nominal GDP in 2002 is _____ 20

27. Nominal GDP in 2003 is _____ 20

28. Real GDP in 2002 using 2002 as base year is ______.

29. Real GDP in 2003 using 2002 as base year is ______.

30. Real GDP in 2002 using 2003 as base year is ______.

31. Real GDP in 2003 using 2003 as base year is ______.

32. Chain-weighted method for real GDP
Calculate growth rate in real GDP using last year’s prices. ______
Calculate growth rate in real GDP using this year’s prices. ______
Calculate the average of the two growth rates. This average growth rate is the growth rate of real GDP from last year to this year.
average growth rate _______
RGDP (using 2002 as base) _________
4. Repeat steps 1, 2, and 3 for each pair of adjacent years to link real GDP back to the base year’s prices.

33. Real GDP and the Price Level
GDP deflator
Avg. of the prices of the goods in GDP in the current year expressed as a % of the base year prices.

34. Interpreting the GDP-deflator
The GDP-deflator provides a comparison of current year prices with base year prices.
If deflator =100, prices are, on average, the same.
If deflator=150, current year prices are, on average, 1.5 times those in base year (50 percent higher)
If deflator=75, current year prices are, on average .75 times those in base year. (25 percent lower)

36. Nominal and Real GDP
Date
Real GDP
(2000 $)
Nominal GDP
1980
5161.7
2786.6
1990
7112.5
5716.4
2000
9629.4
2007

37. The GDP-deflator in 2007 is _____ (give answer rounded to 1 decimal point – e.g. 103.2)

38. The prices in 2007 are ____ percent higher than in 2000
The prices in 2007 are ____ percent higher than in (Give answer rounded to 1 decimal point and exclude % sign – e.g. 5.2 is 5.2%) 20

39. The prices in 2007 are ____ percent higher than in 1990
The prices in 2007 are ____ percent higher than in (Give answer rounded to 1 decimal point and exclude % sign – e.g. 5.2 is 5.2%) 20

40. Measuring Economic Growth
The economic growth rate is the percentage change in real GDP from one year to the next.

41. R-GDP as a measure of economic welfare.
Quality improvements
Household production
Underground economy
Health and life expectancy
Leisure time
Environment
Political freedom and social justice
Exchange rate in comparing across countries.

42. If environmental quality worsens, the growth rate in real GDP will _____ the growth rate in the standard of living
Over-state
Under-state 20

43. If more people begin to hire someone to take care of home projects instead of doing it themselves, the growth rate in real GDP will _____ the growth rate in the standard of living
Over-state
Under-state 20

44. Overstatement Understatement
Suppose U.S. GDP per capita is higher than that in Japan. If people in the U.S. average less hours of work per week than people in Japan, the extra GDP per capita in the U.S. will be an ____ of how much better off people in the U.S are compared to those in Japan.
Overstatement
Understatement 20

45. Exchange rates and comparisons across countries.
Using actual exchange rate, U.S. real GDP per capita = 69* Chinese real GDP per capita
Using PPP exchange rate, U.S. real GDP = 12*Chinese real GDP per capita.
What does this say about actual versus PPP exchange rate?